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CSFXRIGHT DEPOSm 



Investing 

for 

Profit 



By G. C. SELDEN 

Author of 

"Psychology of the Stock Market," "The Machinery of 

Wall Street," "A B C of Bond Buying," Etc. 



The MAGAZINE of WALL STREET 

42 BROADWAY 

NEW YORK 



,v x 



V 



Copyright, 1919 

by 

The Magazine of Wall Street 

Third edition, Revised 



30 19(9 

©CI.A529921 



CONTENTS 

AI. What to Do with Idle Money 132 

XII. The Three Sources of Profit in Buying 

Securities 144 

I. Some Underlying Principles 7 

II. Distribution of Investments for Profit. . . 18 
III. When Should Bonds Be Bought for Profit? 31 
VI. The Selection of Growing Railroad 

Stocks 46 

V. Watching the Standard Rails 63 

VI. Investment Stocks and the Price 

of Capital 73 

VII. Applying Common Sense to Industrials. 82 
VIII. How Industrial Stocks Grow 98 

IX. Buying Stocks in Dull Times 109 

X. How to Interpret the Action of the 

Market 120 



PREFACE 

THE following chapters first appeared as a 
series of articles in The Magazine of 
Wall Street. They were later repub- 
lished in book form in response to a consider- 
able demand for information of this character. 

The reception accorded the first and second 
editions was such as to make necessary the 
printing of this, the third edition, which has 
been carefully revised. 

The first two editions contained a discussion 
of "When to Buy and Sell as Shown by the 
New York Bank Statement." Because of the 
great changes in banking conditions as a re- 
sult of the Federal Reserve System, the effect 
of the war in expanding loans based on Gov- 
ernment paper, etc., the methods there explain- 
ed are no longer applicable in the same way. 
Moreover, the relation between money and 
stocks has been adequately handled in another 
book published by The Magazine of Wall 
Street — "Tidal Swings of the Stock Market," 
by Scribner Browne — to which the reader is 
referred. 

Other matter of equal importance has been 
added to take the place of those chapters. 

G. C. Selden. 
New York, May, 1919- 



CHAPTER I 

SOME UNDERLYING PRINCIPLES 

INVESTMENT is defined as "the placing of 
capital in a more or less permanent way, 
mainly for the income to be derived there- 
from." 

In the very nature of the case the definition 
of investment cannot be rigid and clear-cut, be- 
cause the idea itself is not rigid or clear-cut. 
Like nearly all the terms used in finance or in 
the marketplace, the word is used in a variety 
of ways and has several gradations of mean- 
ing: 

(1) The placing of capital for income only, 
the risk of loss being so slight as to be almost 
negligible. The income from such an invest- 
ment is necessarily small, because the element 
of risk is nearly eliminated. 

(2) The placing of capital for income, but 
in a security which contains a slight possibility 
of loss — or a "business man's risk," as it is 
commonly called. In this case, the investor 
depends to a certain degree upon his know- 
ledge of financial or business conditions in 
forming his opinion as to the safety of his in- 



8 INVESTING 

vestment. He therefore obtains a somewhat 
higher rate of interest, the additional per cent, 
being in payment for additional risk or for the 
degree of judgment which he has exercised in 
making the purchase. 

(3) The placing of capital for income, but 
also with the expectation of an increase in the 
value of the principal — in other words, invest- 
ment for profit as well as for interest. 

Whether investment for profit should be 
called a science or an art is a mere quibble over 
words. Investment for income is commonly 
called a science, and scientific principles may 
certainly be applied to investment for profit, 
but in its main features it might perhaps better 
be called an art. 

It is doubtful whether the intelligent inves- 
tor for profit, who works on sound principles 
and with deliberate judgment, takes any great- 
er risk than the investor described under (2) 
above, who accepts the business man's risk. 

For example, in 1902 Minneapolis & St. Lou- 
is 1st & Refunding 4's of 1949, selling at 106, 
were considered at least a business man's risk, 
if not better, yet they dropped to 61 in 1912; 
while American Beet Sugar preferred, paying 
6 per cent, and selling around 80 in 1902, would 
have been ranked somewhere between a busi- 



FOR PROFIT 9 

ness man's risk and a speculation, yet in 1912 
it was selling at par, after having yielded 7*/2 
per cent, interest during the entire 10 years on 
an investment made at 80. 

It is sound judgment and adequate know- 
ledge of essential facts that command large in- 
come returns, whether in the investment busi- 
ness or any other business. 

This example also illustrates another impor- 
tant fact, namely, that the careful investor for 
profit often gets, in addition to his profits, a 
larger income return than the investor for in- 
come only. This is because the securities 
which are most likely to increase in value are 
generally those of growing* companies and 
have not yet become "seasoned-" For this 
reason such securities sell at a low price com- 
pared with their interest or dividend rates. 

The investor for profit does not primarily 
aim at a high interest yield. He tries to get 
merely an ordinary income return, coupled 
with an increase in value. But he is likely to 
find himself, without any special intention, re- 
ceiving a relatively high rate of interest in ad- 
dition. 

The distinction between investing for in- 
come and investing for profit is not so great as 
might at first appear. The first consideration in 



10 INVESTING 

an investment for income is usually said to be 
safety. This means, of course, safety against 
the loss of any part of the principal. But this 
includes a consideration of future prices, just as 
truly as though the investment had been made 
with the expectation of an increase in value. 

The investor for profits tries to select a se- 
curity that will grow, while the investor for in- 
come tries to select one that will not shrink. 

The difference is in degree rather than in 
kind. The element of risk can never be entire- 
ly eliminated. Even if we were to assume that 
the U. S. Government is indestructible, so that 
the holder of a Government bond is certain to 
receive the full par value of the bond at matur- 
ity, there is still to be considered the risk in- 
volved in the changing value of money. A rise 
in the cost of living means a fall in the value of 
money, and consequently a shrinkage in the 
real value of the bond, which can only be truly 
measured by what the bond will buy. 

This view of the matter has been forced 
home upon investors within the past few years 
by the rapid rise in all prices. Investors have 
supposed that they were taking little or no risk 
because for every $1,000 invested they were 
sure to get back $1,000 at maturity of the obli- 
gation. They have awaked to discover that the 



FOR PROFIT 11 

$1,000 at maturity would buy less than two- 
thirds as much of any useful or desirable 
article as when the investment was made. 

Safety, then, can never be absolute ; it is a 
question of degree. The investor for profit 
seeks a growing margin above the line of safe- 
ty which! will yield him additional capital. 
The investor for income only must likewise 
study to avoid any shrinkage below the line of 
safety which will encroach upon his principal. 

There are many who look upon the art of in- 
vesting for profit as a mysterious and difficult 
"knack." They say of an unusually successful 
man, "He is a natural money-maker/' or "Ev- 
erything he touches turns to money." 

Perhaps one-tenth of the returns obtained by 
a successful investor for profit should be charg- 
ed to natural bent or talent for money-making ; 
but the other nine-tenths would certainly be 
found to be due to his first learning the busi- 
ness, then making a careful and painstaking 
investigation of every proposition before put- 
ting capital into it, studying all the conditions 
surrounding the business of the company, 
comparing prices with conditions, and in gen- 
eral applying to the investment the same de- 
gree of thought, caution and mature considera- 
tion that he would apply to the active manage- 



12 INVESTING 

ment of any business enterprise in which he 
was engaged. 

How many losing investors can truthfully 
say that they have done all this? In ninety- 
nine cases out of one hundred they invested 
"on the recommendation of a friend/' or on the 
strength of alluring advertising matter, or be- 
cause of some half-considered notion, never 
carefully investigated, or for some other equal- 
ly inadequate reason. 

Only three qualifications are necessary in 
order to learn the art of investing for profit : 

(1) Ordinary common sense. 

(2) Willingness to make industrious and 
constant use of your powers of observation, 
reasoning and inquiry. 

(3) Patience to go slowly until actual ex- 
perience has confirmed the soundness of your 
judgment and of your methods. 

These three requirements are not easy, but 
they are not dependent upon any special talent 
and they are within the reach of most persons 
who are willing to make an effort proportion- 
ate to the results they hope to achieve. 

As to the opportunities for this kind of in- 
vestment, they are almost innumerable. The 
inexperienced investor is likely to argue with 
himself somewhat as follows: 



FOR PROFIT 13 

"Look at the millions of dollars owned by 
great capitalists or piled up in banks awaiting 
good opportunities for investment. A large 
part of this money belongs to men who are 
themselves directors in the big corporations, 
or to bankers who know every development in 
all the money markets of the world. What 
chance have I in comparison with these men? 
They are bound to skim the cream from every 
proposition before they let us little fellows in. 
They simply use us to unload on when they 
want to stand from under." 

Now there is a point of view from which 
this is at least partly true. The great banking 
and corporation interests certainly have better 
opportunities for knowing future develop- 
ments than the average small investor and they 
will usually be able to get more profitable re- 
sults. 

But the special advantages of the large in- 
vestor as compared with the small are very 
much overestimated. The most essential facts 
in regard to the money market and the condi- 
tion of important corporations are public prop- 
erty. Certain companies pursue a policy of 
secrecy, and these the outside investor must 
leave severely alone ; but so far as the big rail- 
roads and many of the important industrials 



14 INVESTING 

of this country are concerned, the main facts 
about their condition, earnings and prospects 
are spread broadcast. An officer or director 
may have more exact knowledge than the pub- 
lic as to the date on which a dividend will be 
raised or lowered, but the public may, if it 
wishes, know very nearly as much as he about 
the earnings which underlie the dividend — and 
that, after all, is the important thing. 

Moreover, the fact that leading banking in- 
terests can make their money earn a larger re- 
turn than you can get on yours, does not pre- 
vent you from making a moderate profit. They 
are a long way from usurping the entire field. 
There is still plenty of room left for you. 

Facts are the best answer to this argument 
of the pessimist. For example, in 1903 United 
States Steel preferred sold at 49%. It was then 
paying and has continuously paid ever since 7 
per cent, on par or over 14 per cent, on a 
price of 49%. In 1909 it sold at 131. 

If inside interests knew all the facts and had 
abundant capital, why didn't they buy all the 
Steel preferred that was offered between 50 
and 60? Why was the small investor given 
the opportunity to pick up this bonanza at 50? 
Similar examples might be taken from the his- 
tory of any well known stock or bond. 



FOR PROFIT 15 

Whatever advantages inside interests may 
have compared with the ordinary investor, 
there are plenty of opportunities left over for 
him. 

While there are many different kinds of se- 
curities, which vary in innumerable details in 
regard to legal rights of the holder and the ex- 
act character of the obligation, all may be in- 
cluded under three general heads: 

(1) Promises to pay, such as bonds, mort- 
gages, notes, or loans on collateral. All of this 
class of securities entitle the holder to a speci- 
fied amount of cash at a certain fixed future 
date,* with interest at a predetermined rate, 
payable at regular intervals throughout the 
term of the security. 

(2) Equities, representing a fractional part 
of the ownership of the company. The Eng- 
lish term for these, shares, expresses their 
standing accurately. In America such securi- 
ties are commonly called stocks. 

(3) Convertible securities, which may be 
changed from one of the above forms to the 
other under certain conditions which are speci- 
fied in the face of the security. 

It is to be noticed that the character of a se- 
curity i s not always fairly indicated by its 

*A few bonds have no date of maturity, but remain 
permanently outstanding. 



16 INVESTING 

name. Income bonds, for example, are en- 
titled to interest only when earned. If the in- 
come of the company is sufficient to pay the 
interest on such bonds, it is paid; but if the 
interest cannot be paid, this does not neces- 
sarily throw the company into the hands of a 
receiver, as would be the case if the interest on 
any other bonds were defaulted. 

Likewise the debenture bond is practically 
nothing but a note, as it carries no lien on any 
specified property of the company, but is mere- 
ly a general obligation. When such a bond 
runs for a short term only, it is called a note in 
the ordinary parlance of the Street. 

In the case of a guaranteed stock, it is neces- 
sary to ascertain just what the guarantee cov- 
ers; but in most cases such a stock is equiva- 
lent in safety to a debenture bond except that 
it has no date of maturity. 

Equipment bonds deserve special notice, be- 
cause they are really stronger than their name 
indicates. The security behind them consists 
of specified railroad equipment, as locomotives, 
cars, etc. The company might go into the 
hands of a receiver without affecting the se- 
curity of these bonds, as that depends solely 
upon the equipment. A certain fraction of 
such an issue of bonds is retired each year, 



FOR PROFIT 17 

while the railroad usually obligates itself to 
keep the equipment in good repair and to re- 
place such as may be worn out or damaged 
within the term of the bonds. Hence the 
amount of bonds outstanding keeps decreasing 
in proportion to the security behind them. 

Since the investor for profit desires to select 
securities that will increase in value, he will be 
chiefly interested in stocks and in bonds or 
notes which are selling below par. It is rare 
that he will wish to purchase bonds above par, 
because the possibilities of higher prices for 
such securities are very limited. 

Equipments or any kind of serial bonds sell- 
ing below par are especially attractive because 
the bonds to be retired each year are usually 
drawn by lot, so that each holder has a chance 
of getting par for his bonds whenever any are 
retired. 

The investor for profit must select securities 
which have a ready market. When he sees a 
good profit in his investment, he wishes to be 
able to take it without sacrificing two or three 
points because of difficulty of finding a buyer 
at the moment. 



CHAPTER II. 

DISTRIBUTION OF INVESTMENTS 
FOR PROFIT 

ONE of the standard warnings commonly 
given to the investor is that he should 
never "put all his eggs in one basket." 
On the other hand, Andrew Carnegie, who may 
be supposed to know a thing or two about in- 
vestment, has revised this adage to read, "Put 
all your eggs in one basket and then watch the 
basket." 

Mr. Carnegie has the very great advantage 
of having made a phenomenal success of his 
method, but it is to be observed that he did so 
by watching the basket very closely indeed. 
He did not set the basket on a wall and say, 
"That looks pretty safe — I'll just step over in 
the back lot and pick a few strawberries. "' 

None of that for canny Andrew. He hung 
onto his basket with both hands. Not even a 
circus parade could distract his attention from 
that precious basket. 

The ordinary investor does not have the op- 
portunity of watching the basket as carefully 
as it needs to be watched if all the eggs are to 

18 



FOR PROFIT 19 

be put in it. An example of this occurred some 
years ago when a large part of the funds of the 
Johns Hopkins University was invested in 
Baltimore & Ohio stock. Undoubtedly the 
trustees of the university thought they knew 
the situation of that railroad and that the in- 
vestment was entirely safe. Yet Baltimore & 
Ohio went into the hands of a receiver and the 
work of the university was for a time seriously 
crippled. Fortunately the embarrassment of 
the company was only temporary, and after re- 
organization it soon regained its standing. 

As a general rule, therefore, it is decidedly 
better for the investor for profit to distribute 
his holdings among a number of different se- 
curities. This distribution will ordinarily 
come about in an entirely natural way, as the 
investor sees first one opportunity and then an- 
other of which he wishes to take advantage. 
When a certain amount of his capital becomes 
available for reinvestment, he begins to look 
for a suitable security and it will usually not 
be long before something turns up suited to 
his purpose. 

The average man will not care to invest all 
his surplus funds for profit; he will wish to 
hold part of them as a sort of reserve by in- 
vesting that part for safety only, without con- 



20 INVESTING 

sideration of any possible profit above ordinary 
interest rates. 

An excellent plan is to divide your capital in- 
to two equal parts, a "reserve fund" and a "pro- 
fit fund." The reserve fund is permanently 
placed with a view to safety of both principal 
and interest. The investor does not expect to 
encroach upon this reserve fund unless in case 
of unexpected disaster, illness or something of 
the sort. 

In placing this reserve fund, interest returns 
will receive only secondary consideration. The 
investor will expect to get only the current 
rate of interest available in cases where the 
element of risk is so far as possible eliminated. 
At present that rate would be five per cent, 
or more. 

Government and standard corporation bonds 
and mortgages afford a natural outlet for the 
investment of such a reserve. For those not 
wishing to assume the responsibility of arrang- 
ing and managing an ordinary real estate 
mortgage, guaranteed mortgages are easily 
available. Any good bond house will recom- 
mend a suitable list of conservative bonds. 
For very small sums, the savings banks and 
good local building and loan associations are 
often the most convenient. 



FOR PROFIT 21 

With one-half of your capital thus securely 
provided for, you are then free to invest the 
other half so as to secure, if possible, a profit 
in addition to ordinary interest. As such pro- 
fits accumulate you will transfer half of them 
to your reserve fund, so as to keep the propor- 
tion between your two divisions about equal. 

You are not warranted in taking any more 
risk on profits than on your original capital. 
It seems to be a common failing to risk profits 
in some highly speculative venture where the 
investor would not have thought of placing 
his original capital. There is no logic in this. 
All money is alike, no matter how you come 
by it. 

The next question is, how shall the investor 
distribute that part of his fund which he set 
aside to invest for profit? Shall all this be put 
into stocks, or some into bonds? Shall he di- 
vide it between preferred and common stocks, 
or between railroads and industrials, or in 
some other way? 

It is of interest to see how some of the men 
who have accumulated great wealth through 
successful investment have divided their capi- 
tal. An instance of special value is found in 
the investments of the late Marshall Field of 
Chicago. He was one of the wealthiest mer- 



22 INVESTING 

chants in the country and was well known 
for his safe and conservative methods of doing 
business and of handling capital. He died sud- 
denly, leaving his investments just as he had 
arranged them in the expectation of continued 
activity. A careful study of his estate was 
made by E. S. Meade, of the University of 
Pennsylvania, and is on record. 

Mr. Field's investments totaled over $43,000- 
000 and were as shown in the table herewith : 

Marshall Field 's Investments 

Money $4,301,378 

Open Accounts .' 9,280,084 

Syndicate subscriptions 1,616,450 

Notes : 

High grade commercial 

paper $1,500,000 

Miscellaneous notes . . 818,269— 2,318,269 

Bonds: 

Gov., State and munici- 
pal $472,500 

Railroad 3,888,000 

Public Service .... 1,502,000 
Industrials 928,000— 6,790,500 



FOR PROFIT 23 

Stocks : 

Marshall Field & Co... $3 ,400,000 

Industrials 3,291,950 

Railroads 8,336,200 

Public service corpora- 
tions 1,431,650 

Banks and trust Cos.. . 809,510 
Miscellaneous 891,000—18,160,310 

Grand total $43,069,524 

The open accounts resulted from his busi- 
ness connections, being almost entirely com- 
posed x of a debt of Marshall Field & Co. and 
of money advanced to the Field Museum. 
The syndicate subscriptions were the leavings 
of various underwritings, and have no special 
interest for the investor. , 

The investments in bonds were all of a high- 
ly conservative character. It will be noticed 
that only a small amount of industrial bonds 
were included, and the quantity of municipal 
bonds was even smaller. The first were evi- 
dently avoided because of undesired risks, 
and the second on account of the small yield. 



24 INVESTING 

The investment in Marshall Field & Co. was 
of course of a special character and was un- 
doubtedly profitable. The other industrial 
stocks were all those of prosperous companies 
and were practically all dividend payers, with 
the exception of $1,494,000, which was equally 
divided between the preferred and common 
stocks of certain of ,the newer industrials. 
These were evidently the leavings of syndicate 
subscriptions, and it is probable that the com- 
mon stocks cost Mr. Field but little. Practi- 
cally all of these companies have since become 
prosperous, although some of them were slow 
in reaching that condition. 

The investments in railroad stocks were di- 
vided between the preferred and common 
stocks of eighteen of the principal railroads of 
the United States. Nearly all were dividend 
payers. 

His public service corporation holdings 
were mostly of Chicago Edison and of the 
Chicago Elevated Railways. It is highly prob- 
able that these were secured by participation 
in the original underwritings. 

Holdings of bank and trust company stocks 
were relatively small but highly profitable. 
Probably many of them were acquired years 
before, and under more favorable conditions 



FOR PROFIT 26 

than such purchases could now be made. 

If we eliminate, so far as possible, Mr. 
Field's direct business and personal relations 
and his participations in underwritings, we 
find about half his fortune invested in commer- 
cial paper and in railroad and industrial stocks 
and bonds, as follows : 

Commercial paper $2,318,000 12% 

Railroad bonds 3,888,000 21% 

Railroad stocks 8,336,000 44% 

Industrial bonds 928,000 5% 

Industrial stocks 3,291,000 18% 



Total $18,761,000 100% 

But a part of the industrial common stocks 
were doubtless acquired at merely nominal 
prices. 

Of course, no profit above interest was ex- 
pected on the commercial paper and, in view of 
the character of the bonds included, this state- 
ment was evidently true of nearly all of the 
bonds also. Bonds can be selected which con- 
tain a possibility or probability of profit in ad- 
dition to interest, but hardly any bonds of this 
character were found in the Field Estate. 



26 INVESTING 

On the other hand, it is highly probable 
that Mr. Field hoped for a natural increase 
in value in addition to interest on nearly all 
of the stocks which he owned. The growth 
of the country would tend to bring this on the 
railroad stocks, and the industrials were of a 
character to indicate this expectation on his 
part. 

We may say roughly, then, that about 38 
per cent, of the above investment fund was 
placed with a view to interest return only, 
while the remaining 62 per cent, contemplated 
also the probability of an additional profit. 
Such a distribution of investments was con- 
servative for a man of Mr. Field's wealth. Un- 
doubtedly most millionaire capitalists place a 
larger proportion of their money in more 
speculative channels. Perhaps they are in- 
duced to do this by the feeling that even if 
the whole of any investment should be lost 
they will have plenty left. 

For the smaller investor the conservative 
course is the only safe one, and he could scarce- 
ly go wrong by imitating the general plan 
followed by Chicago's most successful mer- 
chant. 

In considering this question of distribution 
of investments for profit, it may be asked 



FOR PROFIT 27 

whether there are certain lines of business 
which should be favored and certain others 
which may well be avoided. Are the oppor- 
tunities better in some kinds of business than 
in others? 

There is room for a great deal of shrewd- 
ness and judgment in the interpretation of 
public tendencies, wants and tastes. Bell Tele- 
phone is the commonly mentioned example of a 
stock which could have been bought for a song 
by the investor who was far-sighted enough 
to see the possibilities of the invention. The 
telephone was at first regarded as merely a 
curious toy. The man who then foresaw its 
general business use would have been esteemed 
a wild and visionary enthusiast. 

Doubtless never a year passes by without 
the appearance of extraordinary opportuni- 
ties for the investor who can combine sound 
judgment with an active imagination ; but those 
having this combination of talents are very 
few, and most of the so-called investments 
whose promoters appeal to the imagination 
result in disaster to the holders of the se- 
curities. 

As a general thing it is best to stick to 
established companies and avoid promotions. 
It is the rule rather than the exception that 



28 INVESTING 

a new business enterprise has to go through 
receivership before getting on a permanently- 
sound basis. "Getting in on the ground floor' 
is apt to prove a gamble. 

The ordinary investor for profit should 
either avoid mining enterprises ^entirely or 
put into mining stocks only a small fraction 
of his capital. This is because there is always 
doubt as to the future of mine. Its assets are 
hidden away in the earth where they can only 
be guessed at. 

An exception should perhaps be made of 
the porphyry copper companies, whose ore 
lies so close to the surface of the ground that 
it can be estimated with considerable precision. 
Coal mining also is on a different basis from 
the precious metals, as some of the big com- 
panies have such extensive holdings of coal 
lands that supplies are secure for many years 
ahead. 

Transportation stocks are especially to be 
recommended to the investor for profit, because 
it is usually not very difficult to form some 
idea of the probable growth of the territory in 
which they are located. A new country, with 
great natural resources, is bound to develop as 
population grows, and for that reason the se- 
curities of its best transportation companies 



FOR PROFIT 19 

will have good prospects. On the other hand, 
in the older sections the greatest growth will 
be in industrial enterprises, as transportation 
has already been well provided for. 

Among industrial companies, those whose 
products enter into wide and^ general con- 
sumption are to be preferred to those manufac- 
turing articles for an exclusive trade or for a 
few large consumers, as the latter will be more 
subject to the caprices of fashion, to inter- 
ference by new inventions and to the ups and 
downs of business activity. 

Public service corporations, such as street 
railways, electric companies, gas and water 
companies, etc., are, like transportation com- 
pnies, subject to the growth of the communi- 
ties in which they are located. In the the past 
they have sometimes suffered from unexpected 
competition, which had either to be met or 
bought off. That era is undoubtedly past for 
good and municipal control is now the chief 
danger to profits. As a rule, however, it may 
be assumed that such control will be reasonably 
exercised. 

In the last few years both transportation 
and public utility companies have had to meet 
unusual difficulties because their costs have 
risen greatly while the rate increases granted 



30 INVESTING 

them have been much smaller. This is a tem- 
porary condition, due largely to the unexpected 
changes resulting from the war. 



CHAPTER III 

WHEN SHOULD BONDS BE BOUGHT 
FOR PROFIT? 

WHILE either bonds or stocks may be 
bought for profit as well as for inter- 
est or dividends, the opportunities for 
this form of investment are naturally fewer in 
bonds than in stocks. Lender ordinary circum- 
stances the stock of a corporation bears the 
burden of risk, and as a compensation it also 
has all the chances of increased profits. 

Interest on the bonds must be paid as long as 
the corporation is solvent, but is fixed at a 
definite rate for the entire term of the bond. 
Dividends on the common stock may be dis- 
continued whenever necessary or desirable, 
but they may likewise be increased to any de- 
sired rate. 

Such a legal division of risks and income na- 
turally limits the possibilities of profit on the 
bonds, since they can never participate in the 
prosperity of the company beyond their fixed 
rate of interest. 

An effort to straddle the situation is often 
made bv issuing convertible bonds, which bear 

31 



32 INVESTING 

g fixed rate of interest but may be turned into 
stock at a specified price. Such bonds are 
especially desirable from the point of view of 
the investor for profit, because his interest and 
principal are more secure, while at the same 
time the price of his bonds will follow the stock 
in any advance above the conversion limit ; but 
this very desirability is often discounted in the 
price, so that it may be difficult to buy con- 
vertible bonds low enough to suit. Such issues 
are always worthy of careful w r atching, how- 
ever. 

On the other hand, the investor for profit 
will often prefer bonds to stocks, because his 
principal is assured at maturity — provided, of 
course, the company remains solvent. If his 
bonds were well selected in the first place, he 
need not be disturbed by any decline in price. 
The worst that could happen to him under 
such circumstances would be that he might 
have to hold his bonds, receiving the interest 
thereon, until maturity or until improved fi- 
nancial conditions brought the price up again. 
This fact might contribute to the investor's 
peace of mind in times of unexpected trouble 
— a point always worthy of consideration. 

Morever, there is usually a time in the de- 
velopment of any business enterprise when the 



FOR PROFIT 3S 

bonds afford the investor for profit a better op- 
portunity than either preferred or common 
stock — better because safer and because in- 
cluding assured interest as well as possibili- 
ties of profit. 

The investor will often ask, "Should I con- 
fine myself entirely to listed bonds or should 
I consider also especially attractive issues of 
unlisted bonds ?" 

The answer must be that he should confine 
himself to bonds having a fairly active and sat- 
isfactory market, whether listed or unlisted. 
The mere fact of listing is of little value, ex- 
cept as guaranteeing the legality of the bonds, 
and in nearly all cases this can be easily as- 
certained in regard to any unlisted bond also. 
Otherwise, an inactive listed bond has no ad- 
vantage over an inactive unlisted bond. As a 
rule, listed bonds are likely to have a better 
market than unlisted, other things being equal ; 
but the question of a good market is the one 
to be considered regardless of listing. 

Large and well-known corporations, whose 
business and accounts receive the fullest pub- 
licity, are especially desirable in investing for 
profit, and their bonds will usually be listed 
and will naturally be found to have a satis- 
factory market. 



34 INVESTING 

In buying any bond, the first subject to be 
considered is security. In investigating this, 
the situation of the company as a whole must 
be gone over. The personnel of the manage- 
ment, the affiliations of the corporation with 
other companies, property owned, total bonded 
indebtedness, capitalization and its relation to 
income, the physical condition of the proper- 
ty, are all to be looked into carefully. This in- 
formation may be easily obtained from vari- 
ous monthly and yearly manuals. 

The most important consideration is the 
company's "margin of safety" above all its in- 
terest requirements, or the excess of yearly 
earnings applicable to its bonds above what it 
has obligated itself to pay. Earnings are more 
important than assets, because the assets be- 
hind a bond generally get the greater part of 
their value from their connection with the 
company as a going concern. 

The next question is the rank of the bond, or 
its priority of claim as compared with other 
issues by the same company. The general 
principles in regard to the relative position of 
various bond issues are briefly stated as fol- 
lows by Chamberlain in "The Principles of 
Bond Investment" : 

"The secured obligations of a corporation 



FOR PROFIT 85 

are superior to the debenture; lien security is 
surer than guaranty ; lien on realty is stronger 
than lien on personalty; realty that is mer- 
chantable, or that has its own independent earn- 
ing, makes a better lien than realty that can- 
not easily be sold or that has earnings depend- 
ent upon the cohesion of the entire property. 
A first mortgage has a better claim than a 
second; a second than a third; primary liens 
anticipate secondary liens, and secondary liens 
anticipate junior liens. " 

In the consideration of earnings applicable to 
a bond or other security to be purchased, the 
investor for profit will naturally pay more at- 
tention to probable future earnings and may 
often be satisfied with a smaller margin of 
safety in current income as compared with 
current interest requirements, than would the 
investor for income only. 

The investor for profit is seeking to identify 
his interests with a growing property. A bond 
issue by such a company showing only a mod- 
erate excess of earnings over interest will 
prove actually safer, if the investor's ideas in 
regard to the future of the company are cor- 
rect, than the bond of another company upon 
which much larger current earnings are applic- 
able, but which runs a risk of a falling off in 



86 INVESTING 

earnings during subsequent years. 

At the same time the bond of the young and 
growing company will sell at a lower price 
than that of the company which has reached 
its fullest development, as the latter will be 
considered a "seasoned" investment and will be 
more actively sought by investors for income 
only, who constitute far the largest class. The 
investor for profit credits himself with ordin- 
ary business judgment in estimating the pros- 
pects of the corporation whose securities he 
buys. He studies probable future earnings 
just as carefully as he does present earnings. 

This subject will be more fully discussed 
later in connection with investments in stocks. 
The particular question I am now leading up to 
is, under what conditions are bonds more de- 
sirable than stocks as investments for profit? 

Long term bonds are, as a matter of plain 
necessity, the issues to show wide fluctua- 
tions. If a 5 per cent, bond is to be paid off 
next year, a decline of only two points below 
par would place it on a 7 per cent basis while 
an advance of two points above par would re- 
duce it to a 3 per cent basis. Under such con- 
ditions only slight fluctuations are possible. 

The longer the term, the greater the fluctu- 
ation ; but beyond fifty years the influence of 



FOR PROFIT 87 

the time of maturity upon the basis of yield 
becomes so slight as to be unimportant. A 
60-year 5 per cent, bond on a 4^ per cent, 
basis costs 110.34, and a 100-year bond, 110.98 
— an addition of only .64 of a point for the 
40 years additional term. 

If, however, a bond is bought at a discount 
below par, as will nearly always be the case 
in investing for profit, the shorter the term 
the better, if other conditions are satisfactory ; 
for the approach of maturity will then work in 
favor of the investor. 

For example, if a satisfactory 5 per cent, 
bond having ten years to run can be bought 
at 90, the price will advance (other factors re- 
maining the same) about one point each year 
during ten years. Thus if the investor holds 
the bond throughout the entire period, he will 
get a shade over 5^ P er cent, interest on his 
investment and an additional profit of ten 
points. In the meantime, if more favorable 
conditions bring his bond to par before the 
ten year period is up, he has the option of sell- 
ing the bond and looking around for another 
equally good opportunity. 

In figuring bond values the investor will 
naturally consult the bond tables, which show 
at a glance the actual yield at different rates 



38 INVESTING 

of interest for all maturities. In the case of a 
stock, as it has no maturity, the yield is fi- 
gured by simply finding what per cent, the an- 
nual dividends are to the price paid. A 6 per 
cent, stock bought at 87 yields 600 divided by 
87, or 6.9 per cent. It does not matter what the 
par value of the stock may be, as this does not 
affect the yield on the investment. 

With the bond, the question of yield is com- 
plicated by the fact that the purchaser is to 
receive par at maturity, while he may have 
bought his bond above or below par. If he 
bought below par, he makes a profit, so to 
speak, at maturity, which in the bond tables 
is distributed throughout the entire period 
between his purchase and date of maturity, 
thus raising the yield on his investment. Like- 
wise, if he paid more than par, the premium 
thus paid is distributed over the whole time, 
reducing the yield on his investment. 

One or two practical examples will show 
most clearly the circumstances in which the 
investor for profit would choose bonds instead 
of stocks. 

When the Norfolk & Western Railway was 
reorganized in 1896, a study of the map of the 
road and of the plan of reorganization showed 
great possibilities of earning power. Its lines 



FOR PROFIT 39 



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40 INVESTING 

tapped the rich soft coal and coke section in 
the mountains of western Virginia and the 
southern part of West Virginia, giving direct 
and easy transportation to tide-water at Nor- 
folk, westward to Cincinnati and Columbus, 
and northward up the fertile Shenandoah Val- 
ley to eastern Pennsylvania. The road also 
formed one direct line for through traffic from 
the great Eastern cities to Chattanooga and 
beyond, and another from Virginia and North 
Carolina to Cincinnati and the West. 

At this time, of course, neither the preferred 
nor the common stock was paying any divi- 
dends, but the interest on the first consoli- 
dated 4 per cent, bonds had every appearance 
of being secure. Nevertheless, owing to the 
recent reorganization of the company and to 
the general dullness of business at that time, 
these bonds sold as low as 67V2 in 1897. 

Here was a suitable opportunity for the in- 
vestor for profit who could take an unpreju- 
diced view of the future of the company, as 
well as of the current outlook. The table 
herewith shows the development of the com- 
pany as indicated by the prices of the bonds 
and prices and dividends on the two classes of 
stock. 

In 1897, dividends on the preferred stock, 



FOR PROFIT . 41 

though probable, could not be said to be assur- 
ed. Hence it was a medium for the speculator 
rather than the investor. But the bonds, 
bought at or below 75, yielded a safe 5% per 
cent, with good prospects of improvement. 

In 1900, the bonds reached par, at which 
price the opportunities for profit had practi- 
cally disappeared and the investor for profit 
would naturally dispose of them. In the mean- 
time, the preferred stock, 4 per cent, non-cum- 
ulative, had reached & permanent dividend 
basis. As it was not yet "seasoned," it could 
have been bought as low as 67 in 1900, the year 
when the bonds would probably have been 
sold. In two years more the preferred stock 
sold at 98. The investor might naturally have 
considered 95 a suitable price on which to take 
profits on a 4 per cent, non-cumulative stock. 

By this time, 1902, the common stock had be- 
gun to benefit from the company's large earn- 
ings, being placed on a 3 per cent, basis in the 
middle of that year. In the panic of 1903, how- 
ever, it sold at 53%, and 531/2 in 1904, giving 
the investor ample opportunity to switch into 
that issue at a satisfactory price. Earnings on 
the common increased steadily thereafter, 
with the growth of the section served by the 
road and the constantly increasing demand for 



42 INVESTING 



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FOR PROFIT 43 

soft coal and coke. In 1911 it was put on a 6 
per cent, basis, and continued to pay that rate 
until, on account of the exceptional earnings 
piled up during the war boom period of 1915- 
1916, the policy of paying extra dividends was 
inaugurated. The market quotation for this 
stock kept well up with earnings, reaching 147 
in 1916, which price had fully discounted the 
large increase in earnings up to that time. 

An investment of, say, $750 in a bond at 75 
in 1897, sold for $975 in 1900 and reinvested in 
preferred stock at 75, closed out again at 95 in 
1902 and put into the common at, say, 60, in 
1903, would by July, 1913, ten years later, have 
been worth over $2,300, in addition to having 
earned interest varying from 5 per cent, to 6 
per cent, throughout the entire period. At the 
high price of 1916, it would have reached over 
$4,000. And at no time did the investor hold 
any security of a lower grade than that ordi- 
narily designated as a "business man's invest- 
ment. " 

Another interesting example may be found 
in the sinking fund 5's of the U. S. Steel Cor- 
poration, as illustrated herewith in the second 
table. These bonds, placed on the market in 
1903, sold as low as 65. The preferred stock 
was then paying regular dividends of 7 per 



44 INVESTING 

cent, but its low price 49^4 in that y ear 
showed plainly that investors regarded it 
doubtfully. 

There was no serious doubt at that time that 
the sinking fund 5's would be easily taken care 
of. If the investor for profit had bought them 
at 75 in 1903, he could have realized par for 
them in 1906. It may be assumed that he 
would do this, as par for a 5 per cent, industrial 
bond does not leave much chance for further 
appreciation. 

By this time the preferred stock was on a 
sound basis, and in 1907 an opportunity was af- 
forded to buy it at as low as 79y$. It touched 
131 in 1909, but the investor would doubtless 
have taken his profit before that figure, which 
was evidently pretty high for a 7 per cent, in- 
dustrial stock. 

Whether these profits should have been at 
that time reinvested in Steel common would 
be open to debate. That issue was then almost 
too highly speculative for the purposes of the 
genuine investor for profit, yet many conserva- 
tive business men bought and are now holding 
it. Its partial dependence upon the tariff has 
been at times an unfavorable feature. 

These examples, which might be multiplied 
almost indefinitely, serve to show the period in 



FOR PROFIT 45 

a company's development when its bonds may 
be bought for profit as well as interest. In a 
word, the bonds are to be purchased at the 
time when the preferred stock has not yet 
reached an assured position in the matter of 
regular dividends. 

In the growth of the company, the bonds 
are the first to be brought up to the point 
where they are nearly independent of earnings 
and their price is chiefly determined by the 
condition of the money market; next the pre- 
ferred stock comes up to a similar position ; and 
finally the common stock arrives at the same 
plane, as has long been the case with such 
stocks as Chicago & Northwestern, Louisville 
& Nashville, Lackawanna, etc. 



CHAPTER IV 

THE SELECTION OF GROWING RAIL- 
ROAD STOCKS 

RAILROAD stocks, under normal condi- 
tions, afford the investor for profit what 
should perhaps be called his best oppor- 
tunity, when all the various factors in the sit- 
uation are taken into consideration. 

In the first place, the business of a railroad 
is, of necessity, publicly performed. Its tracks 
and equipment are visible to everybody, its lo- 
cation is known, the business along its lines 
can be estimated and aften may be computed 
from current statistics, and evidences of good 
or bad management are plain enough to any 
experienced railroad man, and in many cases to 
the inexperienced likewise. 

Again, the system of railroad accounting, as 
enforced by the Interstate Commerce Commis- 
sion, is now uniform and definite, so that only 
a small knowledge of bookkeeping is necessary 
in order to judge of the prosperity or adver- 
sity of a road. An industrial company may 
put its stockholders off with a brief statement 

46 



FOR PROFIT 47 

that the gross business for the year was so 
much and the net profit so much, without any 
further explanations or details; but the rail- 
road company cannot do this. It is legally re- 
quired to set forth an intelligible statement of 
its earnings and conditions in a certain definite 
and prescribed form. 

Still another advantage of railroad securities, 
as compared with others, is that the business 
of the company is so largely dependent upon 
growth of population and development of gen- 
eral industry. Even a poorly managed, over- 
capitalized road will make money in a rapidly 
growing and prosperous section, while the 
best and most conservative handling may not 
avert a deficit in a region where business is 
stationary or declining. 

This matter of population will be the first 
to be considered by the investor for profit in 
selecting railroad stock. It is quite true that a 
good road may, under certain conditions, make 
rapid progress and build up its income in spite 
of only a small growth in population along its 
lines, but the investor for profit wishes to get 
the advantage of a combination of favorable 
conditions. He can select any road in the 
country for his investment. There is no reas- 
on why he should not select one where the con- 



48 INVESTING 

dition of growth of population is in his favor. 

For example, the census figures show that 
the State of New Hampshire gained only 4 per 
cent, and Maine 7 per cent, in the 10 years 
from 1900 to 1910; while Oregon increased 62 
per cent., California 60 per cent., Arizona 68 
per cent., and Texas 28 per cent. Other things 
being equal, therefore, the investor for profit 
would choose a road running through the lat- 
ter states, as the Southern Pacific, instead of 
one operating in New Hampshire and Maine — 
the Boston & Maine.* A railroad cannot do a 
big business unless the business is there to be 
done. 

The next important point to be investigated 
is whether the business of a road is diversified, 
embracing a great number of different indus- 
tries and products, or dependent to a large ex- 
tent upon a single industry. 

The roads report the character of their 
traffic under six heads, as prescribed by the 
Interstate Commerce Commission : 

(1) Products of agriculture, such as grain, 
flour, cotton, hay, etc. 

(2) Products of animals— livestock, dressed 

•This was written in October 1912. The later course 
of the two securities well illustrated the importance of ths 
principle explained. 



FOR PROFIT 49 

meats, wools, etc. 

(3) Products of mines — coal, coke, ore, etc. 

(4) Products of forests, that is, lumber and 
allied products. 

(5) Manufactures of all kinds. 

(6) Merchandise and miscellaneous. 

The ordinarily well informed man generally 
knows enough about the character of the sec- 
tion through which a road runs to form an 
idea of the nature of its traffic. With the 
growth of large systems, most of the roads 
handle a w r idely diversified business, so that 
this subject is not as important as when there 
were numerous small disconnected lines, each 
one serving a restricted territory. Even the 
"grangers/' which formerly handled a very 
large percentage of agricultural products, now 
carry a diversified business as a result of the in- 
creasing prosperity of the farmers and the 
growth of manufacturing in the sections ser- 
ved. 

If a road is largely dependent upon one in- 
dustry — as for example Lehigh Valley, nearly 
two-thirds of whose tonnage is anthracite coal 
— its prosperity will vary with the activity of 
that industry. This may be a favorable or an 
unfavorable feature, according to circumstan- 
ces. In the 80's, when the price of coal fluctua- 



50 INVESTING 

ted violently and the business was generally 
disorganized, the hard coal roads were at a 
disadvantage; but in recent years since condi- 
tions of partial monopoly have been establish- 
ed in the anthracite industry, the roads have 
flourished because they participated in the 
profits resulting from higher prices for coal. 

The next question is, Is the road being man- 
aged strictly for the benefit of the stockholders, 
or is it in the hands of speculative interests? 
Now that the railroads of the country have 
been gathered into a few large groups under 
the control of great banking interests, most 
investors know the general character of the 
management of the leading lines, or if they do 
not, can easily find out. 

The days of deliberate wrecking of a rail- 
road, as Erie was wrecked by Gould and Fisk, 
are undoubtedly over for good and all ; but 
there is a great difference between capable, ef- 
ficient, economical management, and careless, 
wasteful methods, or management with one 
eye on the stock market. Strong banking con- 
nections are practically a necessity to a rail- 
roal under present conditions. Its income is 
also materially affected by its relations with 
connecting and with parallel lines. "Com- 
munity of interest" often puts a relatively 



FOR PROFIT 51 

weak road in a position to make money, when 
it could hardly keep its head above water under 
strictly competitive conditions. 

The fact that a road is controlled by Morgan 
interests, or financed by Kuhn-Loeb, or is un- 
der Hill management, is not, taken alone, a 
guaranty of success ; but other things being 
eqnal, the identification of a road with inter- 
ests having abundant resources and wide in- 
fluence is to be reckoned as an important asset. 

When we come to the question of capitali- 
zation, it is little use to figure on the capital 
issues per mile of road. The question to be 
considered is, Are the earnings large enough 
to pay interest on the entire capital and leave 
a reasonable balance? Where a heavy busi- 
ness must be handled, a large capitalization 
per mile is necessary; while in a sparely set- 
tled agricultural district, the capital needed 
may be very much smaller. 

It is clear that the amount saved from earn- 
ings will depend to a considerable extent on 
expenditures for maintenance of way and of 
equipment. A road can make its earnings 
show a fictitious increase for a year or two by 
cutting down its normal expenditures for new 
rails, new locomotives and cars, grading, re- 
pairs, etc. Equally, it can include under the 



52 INVESTING 

heading of maintenance, expenses which have 
actually been made for permanent improve- 
ments, thus causing its earnings to appear 
much smaller than they would be naturally. 

No definite figure can be set for proper 
maintenance. The necessary expenses for 
this item vary so greatly for different roads 
and under varying conditions that the average 
investor is obliged to depend on the opinions 
of experts in forming his judgment on this 
subject. When the annual reports of the prin- 
cipal companies appear, the question of main- 
tenance comes in for careful study by statis- 
ticians and financial experts, and the discus- 
sions of the subject in leading financial publi- 
cations generally give the reader a fair idea of 
the situation. Of course, an actual physical 
examination of the line by a competent rail- 
road engineer is the best possible information. 
It is only occasionally that this is available, 
but nevertheless a knowledge of the real con- 
dition of the various roads gradually perco- 
lates through financial circles. 

Net operating income, or the amount left 
over from total receipts, after all expenses of 
operation and maintenance have been deduc- 
ted, is usually the main reliance in judging 
the value of the stock. It should always be fig- 



FOR PROFIT 58 

ured on a per mile basis in comparing results 
of one year with another, or of one road with 
another. An increase of 500 miles within any 
year in the length of lines operated, would 
naturally increase net earnings for the system 
as a whole, but this might not represent any 
improvement in earnings per mile. 

Most roads also have some "other income/' 
not obtained directly from operations. This is 
added to "net operating income/' giving the 
road's "total income. " 

After arriving at total income, the next thing 
is to deduct the fixed charges, or interest on 
bonds, notes, guaranteed stock, etc. The 
amount of this item is always given in the an- 
nual report. An issue of new bonds or notes 
during the year will increase the fixed charges 
in the next annual report, and to that extent 
weakens the position of the stock, which can- 
not be credited with any earnings until after 
all fixed charges are met. 

The sum remaining after fixed charges are 
paid is called "annual surplus," or "balance 
after charges," and the per cent, of this surplus 
to the total income is called "margin of safety." 
If the total income is $20,000 a mile and the 
surplus above fixed charges is $10,000, the mar- 
gin of safety is 50 per cent. 



54 INVESTING 

Perhaps it is the use of terms like "margin 
of safety/' which sound technical, although 
the idea they express is exceedingly simple, 
that leads the average investor to take all his 
information about conditions and earnings of 
a railroad at second hand from the newspapers 
or from circulars of brokerage houses. 

In point of fact, it is nearly as easy to figure 
the earnings on a railroad stock as it is to 
reckon up your personal cash account. You 
earn so much in a year, you spend so much, 
and whatever is left over represents your sav- 
ings. Just so a railroad has certain gross earn- 
ings, certain expenses, a certain amount of in- 
terest to pay on its debts, and whatever is left 
represents surplus, which may be distributed 
as dividends on the stock if desired by the 
management. 

All these figures are very easily accessible 
in various publications which tabulate railroad 
earnings and expenses so plainly that any one 
can understand them. 

The simplest and clearest way of getting at 
this subject will be to take some railroad as an 
example and show just how the investor for 
profit would have proceeded and why he would 
have done as he did. We will take a road 
which has not had an uninterrupted growth, 



FOR PROFIT 55 

but which has passed through a period of bad 
management, and another period of depression 
which was in no way the fault of the manage- 
ment, resulting in each case in the temporary 
suspension of dividends. We shall thus be 
able to see just what advance warning the in- 
vestor had which would have permitted him to 
sell out his stock before the dividends were 
suspended. 

We will select Southern Railway. Taking 
up first the question of location, we find that 
this road gridirons the South Atlantic and Gulf 
states. The census shows that the value of 
farm lands and buildings in the 16 Southern 
states increased from $4,077,000,000 in 1900 to 
$8,964,000,000 in 1910, or about 125 per cent. 
The value of farm buildings alone doubled 
during the decade — a strong evidence of in- 
creasing wealth ; and the value of twelve lead- 
ing crops also doubled. Value of manufactur- 
ed products increased 120 per cent, and total 
wages in manufacturing industries 157 per 
cent. Population gained over 20 per cent. 

There is no doubt, therefore, that the South- 
ern Railway is located in a rapidly growing 
section. In regard to the character of its busi- 
ness, the breadth of territory covered assures a 
diversified traffic. The rapid growth of manu- 



INVESTING 



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FOR PROFIT 57 

factures is an especially favorable indication in 
this direction. 

The road was incorporated in 1894 under 
Morgan leadership, and that house has con- 
tinued to be the banking representative of the 
company. 

Now, coming to the question of income, the 
table herewith shows annual earnings, per cent 
applicable on the preferred stock, dividends 
paid, and range of prices from 1897 to 1916. 
Gross and net earnings and surplus are shown 
on a per mile basis. 

The only figures that may not be fully un- 
derstood by all are those under "per cent, op- 
erating expenses. " This means the per cent, 
of the total operating expenses of the road to 
its total gross earnings. These figures are 
commonly reduced to a per cent, so as to show 
by comparision whether a road is being ec- 
onomically operated — whether a larger or 
smaller part of its gross earnings is being 
eaten up in the cost of handling the traffic. 

The attention of the investor for profit would 
naturally begin to be attracted to this road 
when in 1899 it earned 3.5 per cent, on its 
preferred stock against 1.7 per cent, the preced- 
ing year, and declared 2 per cent, dividends. 
Looking into the matter further, he would see 



58 INVESTING 

that both gross and net earnings were rising 
year by year, and that the surplus had in- 
creased from $93 per mile in 1897 to $388 per 
mile in 1899. He would also notice that the 
per cent, of operating expenses to gross earn- 
ings had fallen from 69.35 in 1897 to 68.46 in 
1899. 

All this looked very favorable, and as the 
road was in a growing territory and backed by 
strong interests, the investor would be war- 
ranted in buying some of the preferred stock, 
which even with a dividend of only 2 per cent, 
would return him a satisfactory income on the 
investment, while prospects of an increased 
dividend seemed good. The price in 1899 
ranged from 41 to 58. 

Year by year he would have the pleasure 
of seeing earnings and dividends increase and 
prices rise. Up to and including 1902, the only 
fault he could find would be that the road was 
paying out nearly all of its yearly surplus in 
form of dividends, and was not building up a 
reserve against the possibility of dull times. 

In 1903, there was a falling off in net earn- 
ings and in surplus per mile; also the per cent. 
of operating expenses rose to 73.18 from a low 
point of 68.41 in 1898. However, 1903 was a 
somewhat depressed year, when a railroad 



FOR PROFIT 59 

could not be expected to make the best pos- 
sible showing, and the decline in net earnings 
was perhaps no more than would reasonably 
be expected under the circumstances. A bet- 
ter record would be probable as soon as bus- 
iness recovered its normal activity. 

This happened in 1905, and in that year 
there was also a slight decrease in the per cent. 
of operating expenses to gross. But in 1906, 
our investor received a jar. At that time, gen- 
eral business was booming. Every railroad 
ought to be able to make as good a showing 
as ever it could. Gross earnings for Southern 
Railway jumped from $6,688 per mile in 1905 
to $7,274 in 1906— nearly double 1897. 

But net earnings showed only a trifling gain, 
surplus per mile declined, and the per cent, 
earned on the stock was only 0.1 greater than 
in the previous year. Something was checking 
the growth of net earnings. What was it? 

The key was found in the per cent, of 
operating expenses to gross, which had risen 
from 72.87 in 1905 to 74.15 in 1906. For 
some reason the road was not handling its 
business economically. 

The reason was discovered quickly enough 
by the reader of financial publications of that 
date. The Southern's train service in 1906 was 



60 INVESTING 

a joke throughout the states it served. Pas- 
senger trains were late, accidents were fre- 
quent, and freight trains moved uncertainly. 
Yards were clogged with waiting cars, and the 
inadequate equipment was constantly breaking 
down. The company had paid out in dividends 
money which should have been expended for 
improvements; consequently, when a big vol- 
ume of business came, it could not be handled 
satisfactorily or economically. 

In the meantime, April 18, 1906, the stock- 
holders had authorized a "development and 
general mortgage" of $200,000,000 in gold 
bonds, of which $15,000,000 was to be issued 
immediately for the "refunding of payments 
for equipment heretofore made and charged to 
capital," for advances to subordinate companies, 
and for double tracking, revision of grades, etc. 

The issuance of these bonds showed the 
pinch the company was in. The price of the 
preferred stock for 1906 ranged from 93 to 
103, or high enough for a 5 per cent, non- 
cumulative stock even of a thoroughly prosper- 
ous company. The investor would take warn- 
ing. His company had stopped growing. 
Hence it was time for him to get his money out 
of it and to place his investment where he might 
hope for a profit in addition to his interest. 



FOR PROFIT 61 

In fact, the investor might well have set his 
limit at par in the first place, on the principle 
that 100 was high enough for a stock of that 
character, in which case he would have got his 
figure in the previous year, 1905, when the 
high point touched was 102. In this instance, 
however, I wish to show how a brief consid- 
eration of a few simple figures, available to 
everybody and readily understood, would en- 
able the investor for profit to perceive the de- 
velopment of unsatisfactory tendencies in the 
earnings of the road. 

In 1907 came the panic, and dividends on 
Southern Railway preferred were discontinued. 
This took the stock out of the class adapted to 
the investor for profit, as his cardinal principle 
is to get interest on his money first and then 
to add profits, if possible. 

In April, 1911, dividends were begun again, 
with all conditions affecting this road appar- 
ently favorable. Earnings on the preferred had 
risen from 0.7 per cent, in 1908 to 9.6 per cent, 
in 1910, and when the report came out it 
showed 11.1 per cent. The price range for 
1911 was 61 to 75, giving the investor a suit- 
able opportunity to repurchase at a much low- 
er price than he sold, if the investment was 
to his liking at that time. The high price for 



62 INVESTING 

1912 was 87%, and dividends had been in* 
creased to 5 per cent. — the full amount that 
can be paid on this issue. 

In 1913, however, the same conditions as 
in 1906 again appeared — a big increase in gross 
brought only a trifling rise in net, and the 
operating ratio climbed above 74 per cent. 
This was a warning that all was not as it 
should be. 

The severe depression which overtook the 
South after the outbreak of the European War 
in 1914, following the utter collapse in cotton 
prices and the absence of a demand for that 
staple at any price, brought about a sharp re- 
duction in the earnings of this road, which was 
promptly reflected by a decline in the selling 
price of the preferred issue, and a little later 
in the suspension of dividends. The decline 
continued during 1915, when it touched a low 
of 42, but thereafter conditions in the territory 
traversed began to improve rapidly, and the 
price of the stock also showed a marked re- 
covery. The regular 5% dividends were re- 
sumed in November, 1917. 



CHAPTER V. 

WATCHING THE STANDARD RAILS 

IT is to be noticed that while the great 
standard companies which do a well main- 
tained business year after year, are not in 
the same position as those companies discussed 
in the last chapter, which must grow as a ne- 
cessary result of their location in growing 
territory, these standard companies neverthe- 
less have their growing periods, and these pe- 
riods can often be distinguished by the watch- 
ful investor. 

To take an example, which will be likely 
to bring out the point more clearly than a more 
abstract discussion, we will examine into the 
history of the New York, New Haven & Hart- 
ford Railroad since 1897. 

I have selected this road because it is per- 
haps the least favorable for the investor's pur- 
pose of any of the leading American railways. 
It is located in New England, the oldest sec- 
tion of the United States, where natural re- 
sources are less bountiful than in most sec- 
tions and have also been pretty thoroughly 
developed in the past. It is a road which has 
had to meet water competition on one side and 

63 



64 INVESTING 

trolley competition on the other. In order to 
hold its own it has been obliged greatly to in- 
crease its capital issues for the purpose of buy- 
ing up steamships and electrics, which when 
acquired have added but little to its income. 
Its New York terminals have also been a 
source of great expense. 

As a result of these various conditions, New 
Haven stock sold as low in 1911 as in 1907, 
and lower in every year from 1907 down to 
date than in the depression of 1896-7. We may 
take it for granted, then, that if the investor for 
profit could distinguish the growing periods in 
the recent history of this stock, he could do 
equally well or better in the stocks of other 
roads which have made greater progress. 

In the accompanying table I have compiled, 
for each year from 1897 to 1912, the earnings 
on this stock, dividend paid, per cent, of oper- 
ating expenses to gross earnings, and range of 
price. These figures show the salient facts in 
the condition of the company year by year. 
All are clear to every reader, with the possible 
exception of "operating ratio" — the per cent, of 
expenses to gross earnings, which was ex- 
plained in the last chapter. 

The novice, in calculating this per cent, on 
any stock, should be careful to distinguish be- 



FOR PROFIT 65 

tween "net operating income" (commonly call- 
ed "net earnings"), and "total income." Op- 
erating expenses may be obtained by deduct- 
ing net earnings from gross earnings ; but total 
income usually includes other items besides 
earnings from operation, such as interest on se- 
curities owned, etc. 

Starting with 1897, we find the stock earning 
8.2 per cent., and paying out practically ehe en- 
tire earnings in dividends. This was perhaps 
warranted because of the firmly established 
condition of the company and the stability of 
its business. The road was not at that time 
under the necessity of piling up a surplus for 
extensions and improvements, as would have 
been the case with a road in newer territory. 
The operating ratio was at a safe figure, 67.6 
per cent. 

At the price of 160 the stock was returning 5 
per cent, on the investment,, which was as 
large a return as could be expected from a 
stock of such high standing, and in view of the 
contracted state of general business in 1897, 
the investor might well conclude that if he 
bought the stock around that price, he would 
have ample opportunity to sell it higher when 
he found such action advisable. 



66 INVESTING 



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FOR PROFIT 67 

For three years he would have been gratified 
to see a steady advance in the price, accom- 
panied by slightly larger earnings on his stock 
and no important change in the operating ratio. 
By the end of 1901, however, he would have 
observed that the operating ratio was creeping 
up, while the earnings on the stock had stop- 
ped increasing and remained stationary at 8.7 
per cent. Early in 1902 he would have found 
his stock at the extremely high figure of 255, 
at which price the yield would be only 3.1 per 
cent. 

Bearing in mind that our investor is plan- 
ning to hold his stock only during the period of 
growth; that the per cent, of earnings on the 
stock has now ceased growing; and that the 
operating ratio has been gradually rising for 
four years; we may conclude that before the 
high price was reached, he would have been 
satisfied to take his profit and to look else- 
where for another investment. 

When the annual report for the fiscal year 
ending June, 1902, came out, he would congrat- 
ulate himself on the sale, for the operating ratio 
for that year jumped to 71.9 per cent. 

In May, 1904, the price dropped back to 185, 
but the investor would not be willing to re- 
purchase, for the operating ratio of the preced- 



m INVESTING 

ing year had been still higher at 73.9 per cent^ 
and earnings on the stock lower at 8.4 per cent 
These figures showed very plainly that tht 
company was not yet down to an economical 
basis in the handling of its business. 

The 1907 report, however, showed a marked 
improvement. Not only had earnings risen to 
12.2 per cent, for 1906 and 9.2 per cent, for 
1907, but the operating ratio for the latter year 
was down to 65.6 per cent., the lowest for over 
ten years. This appeared to demonstrate that 
the company had put itself in a position to han- 
dle the very heavy business of that year in & 
successful and economical manner. 

November, 1907, gave an opportunity to re- 
purchase the stock at 127, and 128 was touched 
early in 1908. There were plenty of opportun- 
ities to buy all sorts of stocks at a bargain at 
that time ; but if the investor had again select- 
ed New Haven, yielding 6.3 per cent, on an in- 
vestment at 127, he would certainly have been 
warranted in sleeping soundly on his purchase. 

When the 1908 report came out, however, h« 
would have been shocked to learn that not 
only had the earnings dropped off to 5.4 pei 
cent. — which was not unnatural in view of the 
depressed condition of business — but also the 
operating ratio had risen to the surprising fig- 



FOR PROFIT 6§ 

ure of 74.4 per cent. An examination of the re- 
port showed that this was due to a large in- 
crease in expenses for "maintenance of way" 
w T hich had been somewhat reduced in 1907. 

The investor would naturally reach the con- 
clusion that the very low operating ratio for 
1907 had been achieved by letting the road and 
equipment run down, and that this deteriora- 
tion had to be made up in 1908, a year of poor 
business. He would be dissatisfied and would 
get out of his holdings and look around for 
something else. 

That investors did exactly this is shown by 
the fact that the high price for this stock was 
175 in June, 1909, while the high price for the 
average of 20 standard rails was not reached 
until September of that year, and in some indi- 
vidual cases, not until December. Investors 
were availing themselves of the strong spots to 
get out of their holdings. But as the high price 
of the stock for 1908 had been only 161, our in- 
vestor would have had ample opportunity to 
get a moderate profit even if he had delayed 
unreasonably long in purchasing in 1908. 

The 1910 report showed that earnings were 
again up to 10.3 per cent., and the operating 
ratio down to 63.7 per cent., so that the inves- 
tor might have been warranted in taking ad- 



70 INVESTING 

vantage of the low prices of 1911, if New 
Haven stock still looked attractive to him. 
But the unfavorable results of the years of 
1911 and 1912 should have warned him that 
his investment was not progressing satisfac- 
torily, so that he could have avoided being 
hung up in it when the severe slump occurred 
in 1913. And the earnings of the later years 
shown were by no means such as to encourage 
reinvestment. 

The investor who bought in 1911 around 130, 
and failed to take his profits on the advance to 
142 in 1912, had at least sufficient warning in 
falling earnings and the relative weakness of 
the price compared with other railroad stocks, 
to lead him to sell before his purchase ran into 
a loss. 

The fact must again be emphasized that no 
sort of golden rule can be drawn from the fig- 
ures given in the table, which can be applied 
to all conditions and circumstances alike. The 
earnings and operating ratio simply give in the 
most condensed form the same information 
that any business man would collect and study 
if he were running a business of his own — the 
relation between earnings and expenses, and 
the per cent, earned on the investment. It is 
merely a common sense proposition, yet many 



FOR PROFIT 71 

inexperienced investors seem to find them- 
selves confused by it. 

It is highly desirable for the student of in- 
vestment conditions, who desires to profit from 
his investigations in a practical way, to keep a 
note book or some rough memoranda showing 
the progress of all the principal railroads. The 
form of table shown in the preceding chapter 
is a good one for that purpose, as giving a 
more comprehensive view. The time required 
to compile the figures is unimportant, as the 
reports on which the table is based appear only 
once a year. 

With these data at hand, the investor at once 
notices any important change in the condition 
of any company, and by comparison with other 
companies he can quickly discover whether 
the change is due to special conditions affect- 
ing that company alone, or is a result of more 
general causes, which are affecting all the 
roads together. 

When he has learned in this way to keep his 
finger on the pulse, as it were, of each railroad 
system, he will begin to see many opportuni- 
ties for switching his capital from a road which 
has stopped growing to one which is apparent- 
ly just beginning to grow, or from a road 
which has just finished a growing period to 



72 INVESTING 

one which has completed a movement of con- 
traction and retrenchment and is again ready 
for a new forward swing. 

Exact information, intelligently digested and 
broadly viewed, is the principal requisite for 
success in investing for profit. 



CHAPTER VI 

INVESTMENT STOCKS AND THE 
PRICE OF CAPITAL 

WHY do sound investment stocks, on 
which dividends are paid regularly 
and are apparently secure, at times 
sell very much below their average or normal 
value over a period of years, and at other times 
very much above that value? And is there 
any way of deciding when they are below their 
normal value and when they are above it? 

If so, the investor will be in a position to 
buy when prices of such securities are below 
normal and to dispose of his holdings when 
prices are above normal, thus adding some- 
thing to the income which he would receive if 
he held his stocks steadily year after year. 

There are two kinds of influences which af- 
fect the prices of investment stocks : 

(1) The price of capital, which is pretty 
closely reflected in the yields obtainable on 
high grade bonds. 

(2) The prospects of the company itself, as 
viewed by buyers and sellers of the stock, 

Prices of the highest grade bonds depend 
78 



74 INVESTING 

almost entirely on the cost of capital. Pay- 
ment of interest and principal on such a bond 
is assured, so there is no reason why fluctua- 
tions in the company's earnings should affect 
its price. It will rise and fall in harmony with 
the supply of capital available for investment. 

The same thing would be true of a standard 
dividend paying stock, if the dividends were as 
firmly assured as the interest on a high grade 
bond. This can never be true, because the 
company has the privilege of suspending or re- 
ducing dividends at will. 

The only strictly logical reason why the 
price of such a stock should fluctuate any dif- 
ferently from the price of a high grade bond 
is the prospect or possibility of a change in 
the dividend rate. But as a matter of fact we 
know from observation that stock prices do 
rise and fall for other reasons, or to a greater 
extent than would be warranted by the possi- 
bility of dividend changes. When all prices 
are falling and investors are in a discouraged 
state of mind, stocks on which there is every 
reason to expect a continuance of the current 
dividends will fall with the others; and when 
the market is booming and everybody is full 
of optimism, stocks on which the permanent 
maintenance of current dividends is by no 



FOR PROFIT 75 

means fully assured will rise with the rest. 

Such price movements afford the discrimin- 
ating investor valuable opportunities to buy 
or sell. 

The income yield on a stock will nearly al- 
ways be higher than the yield to maturity on 
a high grade bond. That is inherent in the na- 
ture of the security. But it is easily possible, 
by examining the yield on the stock during a 
period of years and comparing it with the yield 
on the bond, to note the average difference be- 
tween the two yields, and thus to discover 
whether the price of the stock at any partic- 
ular time is above or below its normal plane of 
income yield. 

To show how this may be done in actual 
practice, we will compare the yields on Atchi- 
son common stock and the Atchison general 
4's. This bond is one of the most stable on the 
list and changes in its price are almost entirely 
due to variations in the supply of investment 
capital. The 6% dividend on the stock was re- 
duced to 5% in 1908 and the first half of 1909, 
but since the resumption of the 6% at that 
time there has never been any real reason to 
doubt the ability of the road to maintain that 
rate. Yet the stock sold above 123 in 1910 and 
at 75 in 1917. And curiously enough, less than 





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FOR PROFIT 77 

9% was being earned for the stock when it 
sold at 123 and 14% was earned in the cal- 
endar year 1917, when it sold at 75. 

The graph shows the income yield on the 
stock at the mean price for each month from 
1907 to 1918. For additional clearness the 
principal fluctuations in the price of the stock 
are also shown at the bottom of the graph. 

The line showing the yield on the general 
4's is computed in the same way. It shows 
yields to maturity, not current income. 

A comparison throughout the period shows 
that the income yield of the stock has averaged 
approximately 1.6% more than the yield on the 
bond. This has been assumed as a normal 
yield for the stock, and is shown in connection 
with the actual yield month by month. 

It is interesting to notice that the reduction 
in the dividend to a 5% basis in 1908 was over- 
discounted in advance by the price of the 
stock, so that even after the cut the income 
yield at the new rate was farther above nor- 
mal than any later yield. And in the same way 
the resumption of the 6% rate was over-dis- 
counted, so that the yield at the new rate was 
considerably lower than any later yield. 

These extreme fluctuations gave the investor 
special opportunities. After the dividend was 



78 INVESTING 

reduced to 5% in 1908 there was no probabili- 
ty of any further reduction ; yet even then the 
investor had a chance to buy the stock around 
70, giving him nearly 7% on his money. And 
when the 6% rate was restored in 1909 there 
was no early prospect of any higher rate, but 
the investor had plenty of opportunities to sell 
above 120, where the income yield was about 
24 of 1% below the indicated normal yield at 
that time, judging by the yield obtainable on 
the bond. 

In the bear market of 1910 the income yield 
on the stock rose again to 24% above normal. 
Earnings for the stock had been 12.1% in 1909 
and were 8.9% in 1910. For the five years 
ended 1910 they averaged 11.1% annually. Any 
idea that the dividend would be reduced was 
fanciful. Yet the stock sold at 91, manifestly 
below its normal value. 

In 1913 there was a close repetition of the 
conditions of 1910 as regards comparative 
yields. In the war panic of 1914 Atchison was 
one of the stocks that held its value best, yet 
its income yield was then half of 1% above 
normal and the stock sold at 89. In December, 
1917, at 75 the stock was a clear bargain, with 
a yield almost 1% above normal, so it was 
not surprising that it sold at 99J4 in 1918, in 



FOR PROFIT 79 

spite of war conditions. 

On the other hand, the investor who was 
studying the stock from this point of view 
would not have been inclined to buy in Octo- 
ber, 1917, although the price fell to 90% in that 
month, for he would have seen that bonds were 
falling equally fast, so that even then the yield 
on the stock was not above normal. 

In making the above comparison a bond and 
stock of the same company has been used 
but this is not necessary, as all bonds of this 
high grade show substantially similar price 
changes. A practical way of handling the mat- 
ter would be to make up an average of the 
monthly yields of several high grade bonds 
and use this average for comparison with the 
yields shown by any stock in which the in- 
vestor is interested. Suitable bonds for the 
purpose, which have available price records for 
a dozen years or more, would be the Atchison 
general 4s, Penna. Co. 1st 4y 2 s, Louisville & 
Nashville unified 4s, and Northern Pacific prior 
lien 4s. 

The above explanation is sufficient to bring 
out the principle, which is, in fact, clear at al- 
most the first glance. It applies to a large 
number of stocks of the investment class which 
have paid their dividends regularly and look 



80 INVESTING 

likely to do so. It has little bearing on the 
more speculative class of stocks, since these are 
usually not owned for income. If the dividends 
on a stock are precarious or temporary, the 
method explained will be of little service. 

Preferred stocks of the highest grade will 
naturally vary much less from the line of nor- 
mal yield than common stocks or preferred 
stocks which are not so strongly protected. 
Take Atchison preferred, on which the 5% 
dividend is usually earned four or five times 
over. Its highest yields have been 6.4% in 
1907 and 6.7% in 1917, at the lowest prices of 
those years, while at the high points of 1909 
and 1911 its yield was 4.7%. Roughly, its fluc- 
tuations have been about twice those of the 
general 4s, and investments in it should be 
looked upon as about the same as in a good 
second grade bond. 

On the other hand, Virginia-Carolina Chemi- 
cal, which has paid 8% dividends regularly 
for many years, sold to yield 10.7% in 1907, 
rose until it returned only 6.2%, fell in 1916 to 
a 10% yield, and has again advanced to a 
7% yield. There were wide price changes in 
it, which this plan would aid the investor in 
gauging. 

If there is any permanent change in the in- 



FOR PROFIT 81 

vestment standing of a stock, it is necessary 
to take that into consideration. For example, 
if average earnings for a stock 1906 to 1910 
were 1*4 times its dividends, and from 1911 to 
1915 3 times the dividends, it would be entitled 
to a somewhat higher price even though the 
dividend rate was the same throughout. 

The plan is not suggested for the speculator, 
but merely to aid the investor in buying to 
good advantage and in selling when his stocks 
are higher than their normal level. 



CHAPTER VII 

APPLYING COMMON SENSE TO 
INDUSTRIALS 

WE cannot apply all of the same princi- 
ples to industrial stocks that we have 
applied to railroads, because few in- 
dustrials furnish the public with complete sta- 
titics as to their operations. In buying most 
industrials, the investor is always somewhat 
in the dark. 

To be sure, he can form his opinion from 
current news reports, or from his knowledge 
of the activity of the business in which the 
company is engaged, or from deductions made 
from net earnings and dividends as given out 
in the annual reports. But this is a different 
thing from working on such definite statistics 
as are given out monthly and yearly by the 
railroads. 

This fact need not discourage the would-be 
investor for profit. If there is one thing in the 
science of investment that needs to be empha- 
sized more repeatedly than any other, it is that 
no rules can be laid down. We can only apply 
to every proposition the same practical busi- 

82 



FOR PROFIT 83 

ness intelligence that we would apply in the 
management of our own personal affairs. 

In fact, the title of these chapters might al- 
most as well be "The Application of Common 
Sense in Buying and Selling Securities, " as 
"Investing for Profit." Each case must be con- 
sidered on its own merits, on the facts that are 
available, and by whatever method is most 
practicable under the circumstances. That is 
the reason why I am to such a large extent 
following the plan of studying actual examples 
of different securities, rather than confining 
myself entirely to abstract principles. 

The most prominent industrial company in 
the world is the United States Steel Corpora- 
tion. How could the investor secure profits in 
addition to interest in buying its stocks? It 
will afford us a convenient and useful example. 

First, what do we know about the steel busi- 
ness, We know — 

That it has been enormously profitable, 
having made more millionaires than any other 
industry. 

That its products are of a staple character, 
so that the consumption of them must contin- 
ue and grow from decade to decade. 

That stocks of raw material can be carried al- 
most indefinitely, with but little expense be- 



84 INVESTING 

yond the loss of interest on the money tied up 
in them. 

That in times of dull business at home, 
steel products can be exported in large quan- 
tities at prices which will at least keep the 
plants in operation, though profits may be 
small. 

That in times of active business, profits are 
very large, probably larger than in almost any 
other line. 

On the other hand, we know that the steel 
trade is always "a prince or a pauper," accord- 
ing to business conditions. Steel and iron 
products are used very largely in new con- 
struction of all kinds. Hence, when there is 
general confidence in business circles, and new 
construction is proceeding rapidly everywhere, 
the demand for steel is greater than the the 
supply. But when new construction is check- 
ed, whether by financial stringency, political 
uncertainties, temporary exhaustion of capital, 
or for any other reason, then the demand for 
steel falls off very sharply and suddenly, and a 
considerable time may elapse before it revives. 

Plainly, if the investor can buy steel stocks 
near the beginning of one of these periods of 
expanding activity, he is assured of a pofit in 
addition to his dividends. If his purchase is 



FOR PROFIT SS 

made at such a time, he can sell out at his 
leisure, either when his stock is as high as he 
thinks it reasonably should be on the basis of 
the dividends it pays, or when the steel indus- 
try has reached such a degree of activity that 
he thinks the probabilities are against further 
gains. He will never get top prices, but should 
always get a fair profit. 

Of the various steel companies, the United 
States Steel Corporation controls nearly half 
the business of the country and presents to the 
public more complete and accurate statistical 
information than any other company. Its an- 
nual reports contain about everything one 
could ask for. Its earnings are given out quar- 
terly. The amount of unfilled orders on hand 
were also published quarterly up to June 30, 
1910, but since that date they have been given 
out monthly. 

it is easily possible to figure out the opera- 
ting ratio of this company, on the same plan as 
applied to the railroads; but it is doubtful 
whether as good results could be obtained as 
with the railroads, on account of the sudden 
fluctuations in the steel business. 

Moreover, in one way we have a still better 
class of statistics available for this company. 
The unfilled orders on hand represent future 



86 INVESTING 

business, and a knowledge of the future busi- 
ness of the company is certainly much more 
valuable to the investor for profit than a study 
of past business. 

Let us examine these unfilled orders for a 
period of years, and see if they afford any use- 
ful indications as to the probable future move- 
ments of the price of Steel stocks. Everyone 
understands, of course, that many other influ- 
ences will enter into the making of the price. 
But the great thing, after all, with an industrial 
company is getting the orders. It might rea- 
sonably be supposed that orders on hand 
would be so much more effective than any 
other considerations as to exercise a strong de- 
gree of control over the price. 

In order to study the relation between un- 
filled orders and the price of the stocks, we 
must get the statistics before us in some intelli- 
gible form so that we can examine them in de- 
tail. The method here employed is that gen- 
erally used by statisticians. It is very quick- 
ly understood and can be applied by .any 
one without any special knowledge, wherever 
several classes of contemporary statistics are 
to be compared and analyzed. 

The first statement of unfilled orders was 
given out in 1902. Therefore, in the diagram 





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*g INVESTING 

herewith, we begin with that year and allow 
an equal space from left to right for each year 
up to 1916. Then we lay out a price scale on 
the left side of the diagram for the price of 
Steel common, and another scale for the 
amount of unfilled orders. When completed, 
the diagram shows the progress from year to 
year of both the price of the stock and the 
amount of unfilled orders, permitting a fairly 
close comparison of the general movements of 
these two factors. 

We use the price of the common stock be- 
cause it is more directly influenced by the 
prosperity of the business than the preferred 
stock, and therefore has fluctuated more wide- 
ly. The common, however, did not pay divi- 
dends through the entire period shown on the 
diagram. For about two and one-half years, 
1904 to 1906, and again for one year, from 
March, 1915, to March, 1916, dividends were 
suspended; and during those two periods the 
investor for profit would possibly have se- 
lected the preferred stock, which has paid 7 
per cent, regularly. The price of the preferred 
has followed that of the common in a broad 
general way, but with somewhat narrower 
fluctuations. It is omitted from the diagram 
to avoid possible confusion. 



FOR PROFIT 80 

During 1902 and 1903, we see that the price 
of the stock moved substantially in harmony 
with the rise and fall of the unfilled orders. In 
the middle of 1904, however, there is a fur- 
ther decline in orders, while the price of the 
stock continues generally upward. This was 
due to the fact that the price of the stock had 
been abnormally depressed in 1903 by the fi- 
nancial panic, and in 1904, with the return of 
easy money, a great part of the depression was 
soon recovered. 

In other words, a great change in the money 
market caused this stock to move in some de- 
gree independent of any change in orders ; but 
the variation is slight, and merely caused the 
stock to advance a little ahead of orders, since 
the orders rose very sharply at the end of 1904. 

Throughout 1905, 1906 and 1907 the corre- 
spondence between the movements of orders 
and stock is really surprisingly close. In 1908, 
we have a repetition of the conditions of 1904. 
A very easy money market, following the 
panic of 1907, caused the stock to rise sharply 
in advance of any increase in unfilled orders. 

In 1909 and 1910, there is a general corre- 
spondence in the movement of the two lines 
on the diagram, but in 1911, following the se- 
vere liquidation of 1910, the price again pre- 



90 INVESTING 

cedes the upward movement of orders, though 
in this instance but slightly, because the de- 
pression of 1910 was not severe. In 1912 and 
later years a close correspondence is again 
shown. 

We see, therefore, that the changes in unfill- 
ed orders do have a very direct connection with 
the movement of the price of the stock. But 
it is one thing to see this fact and quite 
another thing to take advantage of it in a 
practical way. 

In 1904, 1908, and 1914, the investor might 
well have bought Steel — or almost any other 
stock — as soon as the panic was over and eas- 
ier money conditions began to return. In 1911, 
he probably would not do this, because we had 
no real panic in 1910. If the investor had 
the courage and wisdom to buy in these panics, 
he could then be guided in part by the unfilled 
orders as to how long he should hold his stock. 

But let us assume temporarily that the in- 
vestor has no knowledge of panics or of the 
money market, and is depending solely on the 
company's unfilled orders in shaping his 
course. Could he from this source alone, get 
a profit in addition to his interest? 

In each of the four periods of depression 
shown on the diagram we note the following 



FOR PROFIT 91 

facts : 

(1) Unfilled orders, after a sharp decline, re- 
main at a low level for about one year. 

(2) During the latter part of this year the 
price of the stock begins to advance. 

(3) After the year is over the unfilled orders 
also increase sharply. 

(4) In 1906, 1909, 1912 and 1917 the high 
price of the stock and the high record of orders 
came at practically the same time. 

(5) The diagram gave no positive indication 
as to when the end of these advances was im- 
minent. 

If the investor based his operation on un- 
filled orders alone, he would naturally buy 
U. S. Steel stock in 1904, after unfilled orders 
had remained at a low level for about six 
months, and the price had begun to show an 
advancing tendency. The price of the com- 
mon stock was then about $20 a share. 

In 1906 the rapid advance in orders and the 
sharp price movement, together with the ex- 
cited speculation which then existed, would be 
likely to convince him that such a pace could 
not be maintained. 

Morever, in 1906, Steel common paid only 
IV2 per cent, dividends and sold at a high price 
of 5034> while the preferred, paying 7 per cent., 



92 INVESTING 

touched 11334- These prices were evidently 
high for industrial stocks paying no greater 
dividends than those mentioned, which had 
sold within three years at 8}i and 49^4, re- 
spectively. Ordinary business prudence would 
counsel the investor that the immediate peri- 
od of growth for these stocks was near its cul- 
mination, and that the conservative course 
would be for him to dispose of them and look 
about for another opportunity. 

Early in 1908, our investor, again applying 
the same principles, would buy Steel common 
at perhaps 40 or 45, and somewhere before the 
high price of 94% in 1909, he must certainly 
have concluded that his stock was high enough 
for its dividends and prospects, especially as 
unfilled orders were following but sluggishly. 

In 1911, he would perhaps have bought at 
about 60, and in that case would have seen his 
stock decline to 50 on his hands; yet during 
the following year it sold above 80 in spite of 
the government suit, proposed tariff reduction 
and the general scarcity of capital. 

The report for the last quarter of 1912 
showed that the upward trend to conditions in 
steel industry which had been in operation 
for nearly two years had at last begun a re- 
versal. The success of the Democratic party 



FOR PROFIT 98 

at the polls, on its avowed intention to revise 
the tariff radically downward, was another 
big factor which could hardly have been over- 
looked at the time by any wide-awake invest- 
or. The steel industry was built up in this 
country largely as a result of the generous 
protection given to it by tariff preferences. Any 
serious disturbance of that protective security 
was bound to have a depressing effect upon the 
industry itself, and a decline in price for steel 
shares would naturally be expected to follow. 
The investor who bought Steel around 60, in 
1911, would not necessarily have held it until 
1913. He had reason enough for selling it as 
soon as the outcome of the presidential elec- 
tion of 1912 was known. If he, however, held 
on until the publication of the unfilled tonnage 
report for the last quarter of 1912, which was 
available in the latter part of January, 1913, he 
would have found reason enough, in the falling 
off of these figures as against those for the 
third quarter of the same year, for selling. 

Following the actual passage of the new 
tariff schedules which, in the case of steel 
products, were radical reductions, the steel in- 
dustry entered into another period of severe 
depression which continued for about two 
years, and at no time throughout the period 



94 INVESTING 

would the investor, who was carefully watch- 
ing the situation, have noted any definite indi- 
cations which would have warranted him in 
turning to the buying side of Steel. 

There was a constant decrease in unfilled 
tonnage figures, with but one small recovery, 
until the end of 1914, when a small increase 
over the previous quarter was indicated. The 
improvement was perhaps not sufficient to 
prompt action on the part of the investor, but 
when the figures for the first quarter of 1915 
came to hand, showing an increase in unfilled 
orders of approximately 400,000 tons, he would 
certainly be justified in examining the general 
situation very closely to note if the time had 
not arrived to take action. The situation he 
would have found, had he done so, was a typ- 
ical one as far as the general principles of in- 
vestment as here given apply. At the January 
meeting of the Board of Directors of the Steel 
Corporation, the dividend on the common, 
which had been reduced in 1913 from the form- 
er rate of 5 per cent, annually to 2 per cent., 
was passed entirely. This action had precipi- 
tated a large volume of liquidation among dis- 
couraged holders of the common issue, and 
this selling grew to such proportions and was 
apparently so insistent that the Board of Gov- 



FOR PROFIT 95 

ernors of the Stock Exchange deemed it ad- 
visable to establish several successive minimum 
price levels for the stock, the final price level 
being 38, below which it was not found neces- 
sary to go. 

It seemed that a situation had arisen which 
had crystalized opinion unfavorably to the fu- 
ture prospects for steel. Yet, the unfilled order 
figures had already begun to show an inprov- 
ing tendency. The second quarter produced a 
still more marked improvement and the trend 
thus established continued to assert itself in a 
series of wonderful quarterly increases which 
set new records far beyond anything attained 
in the past. 

The investor who was consistently following 
the principles herein outlined would certainly 
have taken advantage of the favorable oppor- 
tunities presented by the urgent public selling 
of Steel in the early half of 1915. That things 
were looking up in the industry could have 
been plainly seen from the increase in unfilled 
orders. Whatever the nature of the new de- 
mands for steel there was no doubt about their 
genuineness, and although the prices prevailing 
for steel products were very low, the demand 
could not continue to increase for any long 
period of time without producing a corre- 



96 INVESTING 

sponding increase in price for the commodity. 
Increased demand at increasing prices was 
quite certain in time to produce increased 
earnings, and that, of course, meant a return 
to a dividend basis for the common stock. 

Where the investor would take his very large 
profit in the tremendous war activity of 1916 
and 1917 is problematical. By the last quarter 
of 1916 it was clear that the price of the stock 
had responded very substantially to the rise in 
unfilled orders, and most investors would per- 
haps be satisfied with the profits then avail- 
able ; but if they were not, still another oppor- 
tunity was offered them to sell at very high 
prices in May and June, 1917. 

The principal point I desire to emphasize in 
this connection is the general method of study 
suggested. There are three steps in this 
method : 

First, a careful consideration of the circum- 
stances surrounding the business of whatever 
company you are studying. 

Second, a systematic examination of the 
statistics which portray these circumstances 
most clearly. 

Third, the working out of a common-sense 
way of taking advantage of the facts brought 
out by your study. 



FOR PROFIT 97 

Such a method would never be fast enough 
to suit the speculator but it will enable the 
conservative investor for profit to seize many 
favorable opportunities. 



CHAPTER VIII 

HOW INDUSTRIAL STOCKS GROW 

AMONG the great variety of industrial 
companies whose stocks are now avail- 
able to the investor, some are growing, 
some are standing still, and some, doubtless, 
will go downhill. 

Is there any practical way in which the av- 
erage investor, without the time or facilities 
for an exhaustive study of all the conditions 
surrounding each one of these companies, can 
distinguish those which are growing from the 
others ? 

The average conservative investor gets a 
fair interest return on his money. He buys 
securities which have become "seasoned," 
which are well regarded by bankers and bond 
houses generally, and which appeal to him as 
thoroughly sound. He tries to keep himself 
constantly in a safe position. He distributes 
his funds among various securities, so that if 
one disappoints him there is a fair chance that 
another may do unexpectedly well and thus 
give him fair average results. 

But the exceptional investor, who accumu- 
lates a comfortable fortune as the years pass, 

98 



FOR PROFIT 99 

is the one who has the "knack" of selecting 
securities which will gradually rise in value as 
well as return a good income. 

The average price of any stock during a 
period of years reflects its actual value with 
considerable faithfulness — but che price at any 
particular time may vary widely from that 
value. This is often due to speculative condi- 
tions. Those who try to anticipate the im- 
mediate future of prices are frequently mis- 
taken in their calculations, so that they are 
willing to pay too much for a stock or to sell 
it too cheaply. 

Again — and perhaps this is the most impor- 
tant cause of the differences between prices 
and values — investors place too much weight 
on current dividends. So long as a rapidly 
growing company does not raise the dividend 
rate on its stock, the piling up of value behind 
the stock passes unnoticed or is not adequately 
reflected in the price; and so long as a com- 
pany which is on the downhill road continues 
to pay the usual dividends, the decline in its 
potential earning power is not fully appreciat- 
ed. 

What is this "value" that we talk about so 
glibly? It represents the capitalized earning 
power of the assets behind the stock. Big 



100 INVESTING 

assets do little good unless they are of such a 
character as to bring increased earnings. Big 
earnings which are merely the result of acci- 
dentally favorable conditions are pretty sure 
to be temporary and are therefore relatively 
unimportant. But growing earnings which 
are based upon a constant increase in the 
productive assets behind the stock are of the 
very highest importance. 

A company which is constantly plowing 
back into its assets a considerable part of its 
earnings each year is building for the future. 

Suppose a steel company earns an average of 
15% annually on its stock for five years. It 
could pay 12% yearly dividends and retain 3% 
in the business, or it could pay 5% and retain 
10% — using the 10% to enlarge its capacity. 
In the latter case its capacity would increase 
50% in the five years. If its average profit per 
ton of business remained the same, and if its 
common stock constituted half its total capital- 
ization, it would then be earning 30% annually 
on the stock. It could then pay 12% dividends 
and still continue to plow in nearly two-thirds 
of the earnings for the stock. 

Moreover, this plowing in of earnings is the 
best possible evidence of the health of the com- 
pany. If it is customarily earning enough so 



FOR PROFIT 101 

that it has a good surplus available to be plow- 
ed in, there is a strong probability that the 
sums thus reinvested will also show good earn- 
ings. It is easy enough to invest money in a 
company in such a way that earnings will not 
be increased much by the additional assets. 
But the company which, starting with one 
talent, earns another talent and reinvests it in 
the business, is pretty likely to show good 
earnings for the two talents — a good deal more 
likely than if it had borrowed the second talent 
from its bankers. 

So plowed-in earnings are valuable not only 
for the increased assets they put behind the 
stock, but for the light they shed on the effic- 
iency and conservatism of the management. 

The easiest way to make clear the full sig- 
nificance of the reinvestment of earnings is to 
take a few examples of well known companies, 
some of which have followed this policy while 
others have not. 

A table herewith compares General Chemi- 
cal and Pressed Steel Car in this respect. The 
annual surplus on each stock after payment of 
all dividends — that is, what the company had 
left over each year for reinvestment in the busi- 
ness — is shown in the form of per cent on the 
stock, together with current dividends and the 



102 INVESTING 



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FOR PROFIT 103 

yearly range of prices. 

In 1906 and 1907 Pressed Steel had larger sur- 
pluses for reinvestment than General Chemical, 
but thereafter the contrast between the two 
companies is very sharp. From 1908 to 1918 
inclusive General Chemical plowed in about 
370% on the stock which was outstanding at 
the beginning of the period, while Pressed 
Steel plowed in about 50%. 

As a result of stock dividends, the holder of 
100 shares of Chemical in 1908 had 175 shares 
in 1918. A hundred shares of Chemical at the 
mean price of 1908 would have cost $5,750, and 
at the mean price of 1918 would have been 
worth about $30,600, in addition to a very lib- 
eral cash income return throughout the entire 
period. 

The same sum, $5,750, invested in Pressed 
Steel in the same way would have been worth 
about $11,825 in 1918, with an average of 2% 
dividends annually, or an income return of a 
little over 6%. 

The investor in General Chemical would 
have had approximately three times as much 
money at the end of the time as the investor in 
Pressed Steel Car. 

General Chemical's net income in 1916 was 
$12,287,000 against $2,140,000 in 1909; in the 



104 INVESTING 

same years Pressed Steel's net was $2,751,000 
and $1,835,000. 

A very interesting point in connection with 
General Chemical was the length of time that 
elapsed before the price responded to the con- 
tinual plowing in of profits. If a stock is leg- 
itimately worth 100, and 10% on that stock is 
turned back into the business and expended on 
assets, it is plain that the stock should then 
be 110. 

Let us apply this principle to General Chem- 
ical and compare the theoretical annual values 
of the stock thus obtained with the prices at 
which it actually sold. In this case the calcu- 
lation is complicated by the frequent stock div-> 
idends. I will therefore compare the value of 
the original stock outstanding in 1906 to the 
holder who retained it throughout the period, 
as measured by the mean price of the stock 
each year, with the theoretical value of that 
same stock as based on the amounts plowed in 
from year to year. 

Without taking up space to present the cal- 
culations, the net result is as follows: 

Mean Market Value. Theoretical Value. 

1906 78 78 

1907 62i/ 2 86 

1908 57y 2 95 





FOR PROFIT 




1909 


78 


101 


1910 


IOI1/2 


113 


1911 


214 


124 


1912 


204 


136 


1913 


215 


150 


1914 


206 


158 


1915 


318 


165 



10* 



This assumes that the mean price of 78 in 
1906 was a just valuation of the stock at that 
time. Then the theoretical value from year to 
year is obtained by adding on the amounts 
plowed in, while the mean market value is the 
worth of the original stock to the holder on the 
basis of prices actually quoted in the market. 

It will be seen that it took the market about 
four years to wake up to the real facts. Even 
in 1910, after $35 per share had been plowed in, 
the stock sold as low as $93, or 20 points below 
its actual value on the basis of the 1906 price. 
But once the true situation was realized, the 
stock came forward with a rush and sold a 
good deal higher in proportion to the produc- 
tive assets behind it than it had sold in 1906. 
In other words, the possibilities of the com- 
pany had been greatly undervalued down to 
1911, when the public woke up to the com- 
pany's real prospects. 



106 INVESTING 

Yet it would seem, as we look back upon it, 
that the value of the stock should have been 
apparent much sooner. The year 1908 was 
one of general depression. Industrial earnings 
were small and many dividends were cut. But 
in that depressed year General Chemical earn- 
ed almost double its dividends, which had been 
raised from 2% to 4% in 1907, and in 1909, a 
year of only moderately good general business 
conditions, earnings mounted to almost four 
times the 4% dividend. 

A second table shows a comparison between 
Goodyear Tire & Rubber and General Cigar. 
The latter has paid its 4% dividend regularly 
and has shown remarkable stability of earn- 
ings — but it has grown slowly, and therefore 
growth has not been reflected by rising prices 
for its stock. Goodyear at the start was a 
close corporation, so that quotations for the 
stock before 1912 cannot now be readily ob- 
tained; but if we assume 250 as its value in 
1911, that same stock would have been worth 
about four times as much in 1918. In 1914 
and 1915 the stock sold far below its indicated 
actual value, as based on earning power and 
the actual amounts plowed back into assets. 



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108 INVESTING 

General Cigar illustrates the fact that a 
moderate surplus above dividends every year is 
always necessary to maintain reserves and to 
make such ordinary improvements as are prac- 
tically essential to keep the business on an even 
keel. 

It is always a question of bookkeeping 
whether expenditures shall be charged to 
"maintenance and depreciation" or to "addi- 
tions and improvements. " Maintenance is a 
very elastic term. What one manager would 
consider adequate maintenance might be con- 
sidered entirely inadequate by another. In 
cases where a company wishes to keep its ap- 
parent earnings at a moderate figure, unneces- 
sarily large amounts may sometimes be char- 
ged off to depreciation. But as books are us- 
ually kept, any company needs a moderate 
annual surplus above dividends. 

The point to be observed by the investor for 
profit is the combination of liberal earning 
power with large annual surpluses above divi- 
dends. That is a sure sign of a growing com- 
pany. 



CHAPTER IX. 

BUYING STOCKS IN DULL TIMES 

WHERE complete statistics are not avail- 
able in regard to the earnings of a 
stock from month to month, or even 
quarterly, it is more difficult for the investor 
for profit to see his way clearly. Yet if he is 
watchful for opportunities he will in many 
cases be able to form a sound opinion as to 
the early future of numerous companies. 

The year 1908, for example, afforded many 
opportunities to buy industrial stocks at low 
prices. How could the investor select the best 
stocks for his purpose — that is, the stocks which 
were likely to have the best advances? 

Turning to the "Bargain Indicator,"* which 
appears in The Magazine of Wall Street, we 
see that in 1908, a year of general depression, 
very few stocks earned more than in preceding 
years. In many cases the falling off was very 
sharp. United States Steel common earned 
15.5% in 1907 and only 4% in 1908; American 
Smelting & Refining, 12.8% in 1907 and 7% 
in 1908; National Enameling & Stamping, 
6.7% in 1907, compared with a deficit of 2.1% 

♦Now entitled "Industrial Earnings and Dividends." 

109 



110 INVESTING 

in 1908, and so on with many others. 

The exceptions to this rule of declining 
earnings are naturally worthy of particular at- 
tention. In some cases there may be special 
reasons for these exceptions; but as a general 
proposition we may say that any stock which 
could increase its earnings in a year when most 
other companies were showing sharp declines, 
would be likely to prove a good stock to own. 

The first example in the "Bargain Indica- 
tor'' referred to is American Malt Corporation 
preferred, which earned 10.6% in 1908, against 
a deficit of 4% in 1907 and earnings of 2.8% 
in 1906. Referring to any one of the standard 
investment manuals, we find that this com- 
pany was incorporated in 1906 as a holding 
company to take over the stocks of the Amer- 
ican Malting Company, which had been a non- 
dividend payer for years. The earning power 
of the corporation was not sufficiently well 
established to warrant the investor in pur- 
chasing. 

The International Harvester Company 
earned 7.8% in 1908, against 6.5% in 1907, and 
5.1% in 1906. This was really a remarkably 
fine showing. We also find, on looking the 
company up, that it was setting aside yearly 
about one quarter of its income for various re- 



FOR PROFIT 111 

serves — insurance, renewals, pensions, depreci- 
ation, contingent losses, etc. Dividends had 
not then begun. 

We would be justified in assuming that here 
was an exceptionally good stock to buy. The 
annual reports were complete and satisfactory, 
and the gross business of the company was 
growing rapidly year by year. The large earn- 
ings must soon be distributed in dividends, or 
if not distributed they would pile up into a sur- 
plus which would result in much higher prices 
for the stock. 

International Harvester Company sold as 
low as 52 in 1908 and 62 in 1909. ' In 1910 a 
333/$% stock dividend was declared, with a 
4% cash dividend on the whole capital, thus 
increased. In April, 1911, the stock was put 
on a 5% basis. The high point for the stock 
was 129^ in 1911, and 126j^ in 1912. 

The next stock on the list to show increased 
earnings in the depressed year of 1908 was 
United States Realty & Improvement — 7.7%, 
against 6% in 1907 and 4.8% in 1906. The 
company was incorporated in 1904 and con- 
trols the George A. Fuller Construction Com- 
pany, Plaza Hotel Operating Company, and 
various other New York realty enterprises. In 
1908 it was a standard company doing a grow- 



112 INVESTING 

ing business. Dividends of Ay 2 % were be- 
gun in 1908, 4%% was paid in 1909, and 5% 
from 1910 to 1914. The stock rose from Z6%. 
in 1908 to 86y 2 in 1912. 

Here was another stock which had excep- 
tionally good prospects, as shown by its an- 
nual earnings and general business outlook. 
All that the investor needed was our old stand- 
ard prescription, common sense. 

Corn Products, then a new company, earned 
8.5% on its preferred stock in 1908, against 
7.2% in 1907, but was not well enough es- 
tablished to be attractive. Also, this com- 
pany's fiscal year then ended Feb. 28, so that 
1908 earnings were all made in 1907, with the 
exception of two months. 

National Biscuit earned 8.1% in 1908, 7.6% 
in 1907, and 7.1% in 1906. The fiscal year then 
ended Jan. 31, so that 1908 earnings were most- 
ly made in 1907, but the following year showed 
up almost equally well at 7.4%. Dividends 
were 4% in 1905, 5% in 1906, 5^% in 1907, 
and 6% in 1908. The company was very ably 
managed and its business was growing steadily. 

The investor had an opportunity to buy this 
stock at 68 in 1908, and even the highest price 
for that year was only 97. Dividends were 
further increased and the stock sold at 161 in 



FOR PROFIT 113 

1912. 

A similar increase in earnings under gener- 
ally unfavorable conditions was shown by 
People's Gas Light & Coke— 6.9% in 1906, 
7.6% in 1907, 8.4% in 1908. This company has 
a perpetual charter of a broad character and 
growth of the city of Chicago is behind its 
earnings. On the other hand, municipal regu- 
lation of the price of gas is an obstacle to in- 
creased profits. Dividends had been paid regu- 
larly since 1897. In 1908 the stock sold be- 
tween 80 and 106 J4, and in 1912 between 103 
and 122^, the dividend in the meantime hav- 
ing been raised from 6% to 7%. 

American Telephone & Telegraph earned 
10.1% in 1908, as compared with 9.0% in 1907, 
and 8.2% in 1906. The great strength of this 
company is too well known to require com- 
ment, and its earnings in 1908 were a splendid 
testimony to its independence of industrial re- 
actions. The price in 1908 swung between 101 
and 132 fi, and in 1911 the stock sold at 153. 
The dividend has been 8% throughout. 

Utah Copper earned 23.3% in 1908, against 
5.9% in 1907, when it was just starting opera- 
tions. The investor would not have cared to 
buy this stock unless he knew something 
about the value of the mines and prospect for 



114 INVESTING 

earnings. At that time the average investor 
did not know much about these points. 

We have since come to understand that a 
porphyry copper is a manufacturing proposi- 
tion, and that ore supplies may be very def- 
initely estimated, without the uncertainties 
that exist in other mining enterprises. It is 
unnecessary to say that if the investor had suf- 
ficient information in 1908, so that he could feel 
confidence in Utah's future, he would have 
made splendid profits by purchasing its stock. 
It sold at 20 in 1908 and at 67 in 1912, while 
in 1916, on account of the great demand and 
record high prices for copper metal, Utah sold 
as high as 130. 

American Car & Foundry earned 23.8% in 
1908, against 20.1% in 1907 and 4.5% in 1906. 
It is characteristic of equipment companies 
that their periods of big earnings are always 
six months to a year behind those of most 
other companies. This is noticeable likewise 
in American Locomotive's earnings. More- 
over, the Car & Foundry fiscal year ends April 
30. Hence these big 1908 earnings were really 
chargeable to 1907 business. 

Earnings on Car & Foundry dropped off very 
sharply in 1909 and did not fully recover until 
the war order period of 1915-1916. Never- 



FOR PROFIT 115 

theless this stock sold at 2Sy 2 in 1908, rose to 
76i/ 2 in 1909, and ranged from 49}i to 63^ in 
1912. In 1908 it was paying 3% ; in 1913 it 
paid 2%. 

The investor would not have bought this 
stock unless he had acted without a full under- 
standing of the conditions; but if he had 
bought it he could easily have secured a satis- 
factory profit within a year. The wide fluctu- 
ations in the earnings of equipment companies 
are well understood by investors, so that the 
price of the stock was not affected as much as 
would be the case with a railroad, for example. 

It is to be borne well in mind that it is 
increased earnings in a year of depression that 
gives the warrant for buying the stocks of a 
company on this plan. In a year of increasing 
business, enlarged earnings would not have any 
such significance. That is the time when all 
stocks should be showing better results. 

The investor for profit is looking for bar- 
gains. Hence he must buy at relatively low 
prices. When the big earnings appear in a 
period of booming business, it is much more 
likely to be time to sell out than time to buy. 
Value of the "Bargain Indicator" 

The great advantage to an investor of having 
recourse to such a classification table of invest- 



116 INVESTING 

ment opportunities as is regularly furnished in 
The Magazine of Wall Street, in the form of 
its "Bargain Indicator/' both of industrials and 
railroads, is strikingly shown in the case of the 
stock Bethlehem Steel common, which during 
the two recent years of depression, 1913 and 

1914, was one of the few corporations which 
was able to show an increase of earnings. 

In spite of this increase, which in both 
years was really notable, the price of the 
stock, on account of the generally reactionary 
tendency of the market, and later on account 
of the outbreak of the war, did not get above 
47 during either year, and sold as low as 30 
in 1913 and down to 25 in 1914. The "Bargain 
Indicator" published in the early months of 

1915, showed that the stock had earned per 
share 6.6% in 1910, 6.8% in 1911, and 6.9% 
in 1912, and during that three year period had 
sold as high as 51. In the year 1913, earnings 
increased to 27.5%, and for 1914, 32.6% was 
earned. The investor needed to know no more. 
It was his cue to buy for the "long pull," and 
his opportunity did not get away from him 
until the sensational advance to 600 began in 
1915. Of course, it was the abnormal situation 
in earnings brought about by the war which 
made that price possible, but it is also a solid 



FOR PROFIT 117 

fact that long before the war was thought of 
Bethlehem's profits had begun to increase 
sharply, and the price of the stock had not res- 
ponded to the betterment in earnings. 

Another illustration of the value of such 
timely comparison is furnished by General 
Motors common stock, which for many months 
headed the industrial bargains in the monthly 
tabulations. This corporation was organized 
in 1908, and failed to show a surplus available 
for dividends on its common stock for the 
years 1909 and 1910. In the following year 
15.7% was earned, 17.3% in 1912, 38.8% in 
1913, and in 1914, during which most indus- 
trials were utterly depressed and deficits in- 
tead of surpluses were the rule, 37.5% was 
earned for the common. The stock did not be- 
gin to discount this remarkable earnings show- 
ing until the month of March, 1915, when it 
crossed par for the first time. From there on 
the advance was both continuous and sensa- 
tional, reaching top figure at 850 in 1916. In 
1913-1914 it fluctuated between 25 and 99, and 
the investor would have had little difficulty in 
picking it up to put away around 50. 

The above examples are but two out of a 
great number of excellent investment oppor- 
tunities which the "Bargain Indicator" has 



118 INVESTING 

called attention to since that feature was first 
introduced in The Magazine of Wall Street. 

Mining Stocks. 

The average investor will not wish to do 
much in mining stocks, because, from the very- 
nature of the business, it is rarely possible to 
estimate with any accuracy future profits from 
the mines. Mining — aside from some of the 
porphyry copper enterprises — is not a busi- 
ness; it is a form of exploitation. A mining 
company simply takes metal out of the ground 
and distributes it in form of dividends to the 
owners of the mine. When the ore gives out, 
the dividends give out also. 

Hence an investor in a mining stock must al- 
ways be, in a sense, an investor for profits, as 
his company does not earn dividends in the 
same way that a railroad or an industrial cor- 
poration earns them. 

The time to buy mining stock is when it is 
an assured prospect, and the time to sell is 
when the dividends are at their height. An ex- 
perienced mining man lays down the following 
rules for the buyer of mining stocks : 

(1) A mine must be well located in an ore- 
bearing district. 

(2) The investor must know that the man- 



FOR PROFIT 119 

agement of the mine is both capable and hon- 
est. 

(3) Buy when the company is in the pros- 
pect stage, before it begins the payment of 
dividends. 

(4) When you can double your money, sell 
out, even though large dividends are then be- 
ing paid. You may get only a fraction of the 
possible advance, but you will have a big profit 
and you will have your capital in hand and be 
ready for something new. 



CHAPTER X 

HOW TO INTERPRET THE ACTION OF 
THE MARKET 

HOW much attention, if any, should the 
investor for profit pay to the stock 
market from day to day or from week 
to week? Has he anything to gain from 
watching current fluctuations and volumes, or 
studying the general behavior of the market? 

We may answer at once that he should pay 
relatively little attention to these things. 
Earnings and values, growth of population and 
of business, dividends and money rates, politi- 
cal conditions and the accumulation of capital, 
are .of far more importance and significance to 
the investor than any indications he can draw 
from the temporary and often erratic fluctua- 
tions of prices. 

Yet this question of the action of the market 
should not be entirely ignored. It is a well- 
known fact that some professional speculators 
are able, by carefully watching the technical 
indications derived from a study of volumes 
and prices, to make more money during the 
year than they lose. 

This is very far from being the ideal of the 
investor for profit. He wishes to keep him- 

120 



FOR PROFIT 121 

self always in a safe position, and his first con- 
cern is a satisfactory interest return on his 
money. But the above fact does show that 
the action of the market is a subject worthy of 
some attention in connection with, but strictly 
subordinate to. other more important matters. 

What are the elements with which the stu- 
dent has to work, in endeavoring to interpret 
the action of the. market? This is a point on 
which even those who are constantly in touch 
with the technical situation are apt to have 
only a hazy and indefinite notion. 

Reduced to its lowest terms., the action of 
the market includes three basic factors : 

(1) Price. 

(2) Time. 

(3) Volume, that is, the number of shares 
bought and sold at a certain price or during a 
certain time. 

Each of these three factors may be recorded 
or used in different ways, and the three, or any 
two of them, may be combined according to 
different plans. 

Without going into the numerous ways in 
which these factors are recorded and studied 
by speculators, a few practical observations 
may be offered which will be of use to the in- 
vestor. 



122 INVESTING 

First, no important conclusions can be ob- 
tained from any one of the three factors, taken 
alone. It is the varying relations between two 
or three of them that serve to give the market 
a sort of character of its own. 

Second, the element of time should always 
be included. Attempting to draw conclusions 
from a combination of prices and volumes, 
without reckoning in the lapse of time is, in 
my opinion, unsatisfactory. 

Third, a study of time and volume without 
prices would be meaningless, as the investor 
cannot buy or sell except at some price. 

These principles simplify matters somewhat. 
There are, in fact, only two combinations left: 
(1) Price and Time; and (2) Price, Time and 
Volume. 

In many markets volumes are not recorded. 
They are not obtainable in any of the English 
markets, either for stocks or for commodities, 
so far as I am aware. They have never been re- 
corded on the Chicago Board of Trade. They 
were formerly sent out on the cotton tickers, 
but the practice was discontinued some years 
ago, as the market got so big that it was very 
difficult to keep track of them. 

Even in the New York Stock Market there 
is a good deal of inaccuracy about the record- 



FOR PROFIT 128 

ing of volumes, and the totals as figured up 
by the ticker companies and newspapers can be 
accepted as approximate only; but the errors 
(aside from occasional clerical or typograph- 
ical mistakes) are not great enough to inter- 
fere seriously with any conclusions to be 
drawn. 

Almost all investors glance over the stock 
list in their morning papers to observe the 
general movement of the market, and notice 
the total transactions for the day; but if they 
depend only on their memories for past prices 
and past volumes, and for the time that has 
elapsed since those prices and volumes were 
recorded, they fail to get any adequate idea of 
the action of the market. It is desirable, and, 
in fact, almost necessary, to keep some brief 
record from day to day, or at least from week 
to week. 

The most practical way to do this is to make 
a simple "graph" of the average of the prices 
of a considerable number of prominent stocks, 
usually twenty or more. The investor records 
each day the average of the high prices of all 
the stocks selected, the average of the low 
prices, and the average of the closing prices. 
Several daily papers compute and publish such 
averages daily, to save work for their readers. 



124 INVESTING 

One of the best is found in the New York 
Titnes, which averages twenty-five railway- 
stocks, also twenty-five industrials, and then 
combines the two into an average of fifty 
stocks. 

A simple way to keep this record is to use 
paper ruled into small squares, placing the 
scale of prices at the left and the dates day by 
day at the top. Then a short line is drawn 
under each date, extending from the point on 
the scale representing the average high price 
to the point for the average low, with a tick on 
the right side of the line showing the average 
closing price. 

The accompanying illustration 'will make 
the meaning clear. 

Since only two factors can be recorded on a 
graph by a single line, it is necessary to add an- 
other line along the bottom of the chart to 
represent the volumes. For this purpose it is 
best to use the total sales for all stocks, wheth- 
er included in the averages or not, as what you 
want is a general picture of the whole market, 
as nearly as it can be obtained. A scale of one 
hundred thousand shares to the space, at the 
lower lefthand corner of your chart, enables 
you to carry a continuous line across the paper 
showing the variations in the total transac- 



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126 INVESTING 

tions from day to day. 

Individual stocks can, of course, be handled 
in the same way if desired, but the investor 
will not usually care to bother with these, as 
he will select his stocks on the basis of earning 
power, interest return, etc. What he wants to 
get from his graph is a general view of the 
entire market. 

When he has his graph, what can he get 
from it? 

He is chiefly interested in the highest prices 
and the lowest prices over a period of a year 
or two as he has no intention of trying to 
catch intermediate speculative fluctuations. 
Are there any distinguishing features of the 
market at these grand turning points? 

Common sense tells us that the lowest prices 
are likely to be made when the most people 
are trying to sell, and the highest prices when 
the greatest number are anxious to buy. We 
shall expect, then, that the volume of sales 
will be relatively large at the top and the bot- 
tom, and this conclusion is borne out by his- 
tory. 

A heavy trade in stocks is pretty sure to be 
accompanied by relatively wide fluctuations in 
prices — the whole market gets bigger, in every 
way. So we find that at these turning points 



FOR PROFIT 127 

the range of prices for the day, as shown by 
the length of our lines on the graph connect- 
ing the average high with the average low, 
will be relatively wide. 

After a period of heavy selling pressure, 
buyers are not likely to rush in the moment 
the selling ceases. They fear a renewal of the 
liquidation, and will only begin to buy gradu- 
ally, as the market becomes quieter and more 
settled. Consequently a period of activity — 
that is, big volumes and wide daily ranges — at 
low prices, is usually followed by a time of 
dullness without any very great change in the 
general level. 

The same principle, of course, applies after 
great activity at high prices ; but the period of 
activity may be longer and the period of dull- 
ness shorter than at the bottom, because spec- 
ulation is naturally broader at high prices and 
the public participation in the market more 
general. 

The mistake must not be made of supposing 
that the action of the market alone will indi- 
cate the top and the bottom. It will not. Con- 
ditions will determine those points, and the in- 
vestor will often be misled if he tries to de- 
pend solely on the principles mentioned above. 

To illustrate, the market may decline sharp- 



128 INVESTING 

ly to a low level, with big volumes and wide 
ranges, and then turn dull. But this does not 
tell us whether prices will not later fall to a 
still lower level, with still heavier volumes and 
still wider fluctuations. Something of this 
kind happened in 1907. After the "Silent 
Panic" of March, the observer might have im- 
agined that bottom had been struck, but the 
conditions which caused the decline had not 
been cured. A still greater smash, in October, 
1907, was necessary to lay the foundation of 
a new bull market. 

These periods of extreme prices and big mar- 
kets come only occasionally. In the meantime, 
can the investor draw any conclusions as to 
the "trend" of prices? He must be very cau- 
tious in endeavoring to do so. This is a diffi- 
cult art, and few have the time or the special 
talent to master it. 

Probably the best indication of the trend of 
the market that is easily available to everybody, 
is found in the comparison of the total vol- 
ume of trade on days when the market moves 
sharply upward, with the volume on declines. 
In a bull market, buyers come in on the ad- 
vances. In a bear market, they refuse to do 
so. In a bear market, holders are urgent to 
sell on declining prices. In a bull market, they 



FOR PROFIT 129 

hold on stubbornly. 

The result is that, in a bull market, the vol- 
ume of trade is likely to increase on the ad- 
vances, while in a bear market it will probably 
become heavier on declines. But this principle 
can only be interpreted and applied to the mar- 
ket by long study and careful observation. 
The novice finds many stumbling blocks. 

One of them is that he is almost sure to lay 
too great weight on small movements, caused 
only by professional operations. Professional 
traders make prices temporarily, but they have 
very little influence on the general trend of 
prices over a considerable period. They are 
merely trying to follow this trend, not to make 
it. The attitude of investors creates the trend, 
and no useful indications as to its direction can 
be gained from fluctuations caused only by 
professional speculators. 

Another point is this : Increased public buy- 
ing, causing a larger volume at higher prices, 
is a characteristic of a bull market; but if this 
is followed by decreased volumes on a reaction, 
nothing is shown exeept the cessation of buy- 
ing — there is no guaranty that it will be re- 
newed, though perhaps there is usually some 
probability that it may be. And a similar 
principle applies, of course, to a bear market. 



130 INVESTING 

One other observed fact in regard to broad 
market movements may be mentioned, as pos- 
sibly of some service under certain conditions. 
After a prolonged period of dullness the inves- 
tor may often be in doubt as to the next prob- 
able move. The market may be in a state of 
balance, and merely awaiting a new impulse, 
which may be in either direction. 

In such cases, the first sharp move on in- 
creased transactions is likely to be continued 
for some distance. The reason of this is that 
speculators, tired of inaction, will follow the 
new lead until they see some signs of its be- 
coming exhausted. 

This little point is sometimes useful to the 
investor. For example, he might consider 
prices relatively high and might be hesitating 
whether to take his profits or wait for a further 
advance. Under such circumstances, if a sta- 
tionary market suddenly turned weak on larger 
volume of trade, he would perhaps accept this 
as a warning that the time had come to turn 
his stocks into money. 

The investor will be positively injured by 
any study of the action of the market if he al- 
lows himself to be diverted from his original 
purpose and led astray into the byways of 
speculation. Active trading in stocks is a vo- 



FOR PROFIT 131 

cation, and a very exacting one ; but investing 
for profit may safely be followed as an avoca- 
tion, with only a moderate amount of atten- 
tion. 

Trying to mix active trading with investing 
is as bad as mixing drinks. 



CHAPTER XI 



WHAT TO DO WITH IDLE MONEY 

THERE will of course be times when the 
investor for profit cannot see any at- 
tractive opportunity for the use of his 
money in stocks or bonds. He may feel that 
the general financial situation is so doubtful 
that even the best of securities may be pulled 
down with the others; or he may be able to 
find plenty of good, growing companies, in 
which he would gladly invest at lower figures, 
but the market may be at such a high level 
that he is unwilling to pay current prices. 

In such cases he will find his money temp- 
orarily idle and the question at once arises, 
what is to be done with it pending the develop- 
ment of a suitable opportunity for re-invest- 
ment? 

It is easy to exaggerate the importance of 
this question. Even supposing his money lay 
in a bank without any interest for a year, the 
loss of interest could hardly be figured at 
more than 5 per cent., and if as a result of this 
delay the investor was able to buy some stand- 
ard stock ten points lower than he could have 

132 



FOR PROFIT 133 

bought it at the time his money was first re- 
leased, his profit from the transaction might 
reasonably be considered as twice the amount 
of the interest lost. 

We have, however, laid down the proposi- 
tion that the investor for profit should consider 
safety and rate of interest first, and then should 
make whatever additional profit he can as 
opportunity arises. If he places profit first 
he becomes practically a speculator and much 
that has been included in these chapters would 
not accurately meet his requirements. 

The first point that naturally occurs to us 
is that 2 or 3 per cent., and in some localities 4 
per cent., can be obtained by placing idle money 
in a trust company, rather than in a national 
bank. In Xew York it is difficult to get more 
than 2 or 2% per cent, on checking accounts 
from the strongest trust companies, but in 
many outside cities 3 per cent, is easily obtain- 
able, and in the newer sections of the country 
4 per cent., and in some cases even more. 

Good private banking houses in New York 
City pay 3 per cent, on checking accounts, but 
the investor will not care to place his funds 
with them unless he has a pretty good knowl- 
edge of the men in charge. Some private bank- 
ers are as sound as any trust company and 



134 INVESTING 

may be even more conservative in the handling 
of their funds, but the difficulty for the ordin- 
ary investor comes in separating the sheep 
from the goats. For such a trifle as % or 1 
per cent, yearly he cannot take any chances 
whatever. 

No one can afford to place his money with 
the trust company or the private banker of- 
fering an exceptionally high rate of interest. 
The high rate would not be offered unless 
there were some reason for it, and that reason 
usually is that the concern has difficulty in get- 
ting money at the current rates paid by other 
houses similarly situated. In other words, 
they are not fully trusted by those having 
large capital at command; and if that is the 
case they certainly should not be trusted by 
those whose capital is smaller. 

The instance comes to mind of a large 
New York trust company which advertised 
a few years ago for checking accounts, offer- 
ing about half of 1 per cent, more interest than 
would usually be paid on such accounts. A 
year or two later the company was in the hands 
of a receiver. 

Still more recently a national building and 
loan company advertised rather widely offer- 
about half of 1 per cent, more interest than 



FOR PROFIT 135 

paid by others. It had been doing this for five 
years or more; but the time came when the 
State banking department refused to permit 
it to continue longer in business owing to the 
insufficient security behind its borrowings. 
To any one understanding the business of a 
building and loan association, this additional 
one-half per cent., in the circumstances under 
which it was offered, was like a red flag. 

If the investor has any considerable sum — 
say $10,000 or more — of idle money, about the 
only way he can get better than trust company 
interest on it is to put it into commercial paper, 
short term notes, or bonds that mature at an 
early date. 

The objection to this is that he never knows 
just when a big decline in the market may come 
which would put prices on a plane where he 
would want to buy stocks or bonds. It might 
happen that just at the moment when he 
wanted his money to invest, it would be tied 
up in short term notes, and when the notes 
matured the opportunity might have passed. 

In any ordinary market, however, he could 
use his notes as collateral with his broker or 
trust company for the purchase of the stocks 
or bonds wanted. As he would buy outright, 
not on margin, he would simply be transfer- 



136 INVESTING 

ring his funds from the short term securities 
into others. At even 60 per cent, of their value 
the notes would give him a credit of 60 per 
cent, on the stocks he wants to buy. This would, 
of course, be ample under any ordinary cir- 
cumstances. 

Once or twice within the last twenty-five 
years there have been intervals of a few days 
when it would have been difficult to get brok- 
ers to accept any collateral whatever, no mat- 
ter how gilt edged, because it was practically 
impossible for them to borrow money on any 
terms. As a rule, however, the investor would 
prefer, in these exceptional cases, to wait until 
the extreme pinch of panic was over before 
buying, even if he had to pay a few dollars 
more per share for his stocks. 

He can't expect to buy at the bottom. The 
attempt to do so would be likely to result in 
his buying too soon and having to stand a fur- 
ther decline. And even if he were to make up 
his mind beforehand to jump at the very worst 
moment of the panic — or what he thought to 
be the worst moment — the lhances would be 
100 to 1 that when the time came he wouldn't 
have the courage to do it. 

The fact is that when the investor appears at 
his broker's office with a perfectly good $10,000 



FOR PROFIT 137 

short-term note in his hand and says, "I want 
you to take this and buy me $10,000 worth of 
sound investment stocks," the broker is going 
to leave no stone unturned to finance the deal. 
It may be questioned whether most brokers 
wouldn't have managed it somehow, even in 
the darkest days of 1907. 

In the selection of short-term notes, com- 
mercial paper, or long-term bonds having an 
early maturity there is a wide range of choice, 
and consultation with your banker or brok- 
erage house is desirable. The rate of interest 
obtainable will generally be from 41/2 to 6 per 
cent., though there are times when 7 per cent, 
can be had. 

Quite recently the holding company idea has 
been applied to commercial paper. Companies 
have been formed to buy two-name paper of 
many different firms and to issue on this paper 
as a basis, their own collateral lien notes at 
perhaps one-half per cent, less interest, having 
practically any date of maturity desired by the 
purchaser. This distributes the risk in such a 
way as to make the notes exceptionally good — 
assuming, of course, that the central company 
is honestly and competently managed. 

In this matter the small investor has an ad- 
vantage over the larger one, because the 



138 INVESTING 

amount of money he will wish to withdraw 
when he is ready to buy will be relatively un- 
important to the institution which parts with 
it. He will therefore have less trouble in get- 
ting it promptly under conditions of financial 
stringency. He can also advantageously make 
use of two classes of institutions which have 
been created for the special benefit of the man 
w r hose capital is limited — the savings banks 
and the building and loan association. 

Even the investor with $10,000 or more can 
use the savings banks and building and loan 
associations by distributing his money about in 
half a dozen or a dozen different institutions, 
so that the amount to be drawn from each one 
when needed would not be so large as to re- 
quire notice before withdrawal. Such a dis- 
tribution of funds has the advantage of greater 
safety, as the loss from the failure of some one 
institution would be relatively small. It is con- 
siderable trouble, however, when the investor 
wants all his money, to collect it together from 
so many different sources. 

The investor with a few hundred or a few 
thousand dollars can easily get 4 per cent, in- 
terest by placing his funds in two or three 
savings banks. The thing that may prevent 
him from doing so is the "sixty-day clause, " 



FOR PROFIT 139 

which permits the bank to require sixty days' 
notice of withdrawals whenever its officers 
consider that necessary. Under ordinary con- 
ditions notice is not required on small sums ; 
but the investor remembers that stocks and 
bonds sell lowest under extraordinary condi- 
tions, so that the sixty-day rule might be en- 
forced just when he wanted his money. 

In fact, this was the case in 1907. The sav- 
ings banks were enforcing this rule, at least 
nominally, for a month or more after the worst 
of the panic was over. 

It should be borne in mind, however, that the 
rule applies chiefly to actual cash. The small 
depositor who wants his money in the form of 
a check, for the purpose of buying stocks out- 
right and paying for them in full, can get it in 
practically every case by using a little persist- 
ence. If the cashier has not been given the au- 
thority to make any exceptions from the rule, 
some higher officer of the bank will usually do 
so if consulted. 

The savings banks apply the rule for the 
protection of their depositors, not to cause 
them inconvenience. The bank's officers would 
be likely to frown upon margin purchases, 
but the real investor, who explains frankly 
what he wishes to do and wants a check to do 



140 INVESTING 

it with, nearly always gets it. The buyer of 
stocks in a panic is performing an important 
public service, and the intelligent bank official 
will look at it in that light. 

Brokers, also, will do everything possible to 
help the small investor in such cases. If the 
bank depositor cannot get his money from the 
bank, the broker will perhaps accept the bank 
book as a temporary deposit for the purchase 
of stocks or bonds in a panic. The broker, like 
the banker, would be likely to discriminate 
against the buyer on margin at such a time, 
but he welcomes the genuine investor who 
wishes to buy outright. 

Those building and loan associations which 
are operated on the savings bank plan, as many 
of the larger ones now are, receiving deposits 
and permitting withdrawals as desired, are 
worthy of more attention in this connection 
than they generally receive. They pay from 
Ay 2 to 5 per cent, interest in the East and high- 
er rates in other sections ; and in 1907 no im- 
portant association, so far as I can learn, was 
obliged to limit withdrawals. 

This is because the depositors in these as- 
sociations are not of a class to be easily fright- 
ened. Most of the deposits are made with a 
view to home-building, and depositors who 



FOR PROFIT 141 

would wish to withdraw, either from fear or 
for investment, in times of stringency, are so 
few in proportion to the whole number that 
their requirements are easily met. 

Some discrimination must be exercised in re- 
gard to such associations. The so-called "na- 
tional" building 4 and loan schemes — that is, 
those associations or companies which have 
charters permitting them to place loans any- 
where in the United States — must be religiously 
avoided. It is impossible for the authorities 
of any State to oversee their operations, and 
the national government has never done so ef- 
fectively. Even the officials of these national 
companies have often been inadequately in- 
formed about their own loans; and in some 
cases they have apparently tried to see how 
closely they could balance on the line of fraud 
without being prohibited the use of the mails. 

Local building and loan associations, which 
can loan only within a restricted territory, 
have shown a good record for many years. In 
States where, as in New York, they are under 
the supervision of State officials, they are as 
a rule just as safe as the savings banks. Na- 
turally, there can hardly be any better securi- 
ty for loans than newly-built homes. 



142 INVESTING 

Of course there is nothing to prevent the 
small investor from buying commercial paper, 
short-term notes, or early-maturing bonds, 
just the same as if he had more money. Con- 
sultation with the old lot houses will usually 
put him in touch with something issued in 
small denominations that will meet his re- 
quirements. Some of the companies which is- 
sue their own collateral lien notes based on 
varied holdings of high grade commercial pa- 
per, as mentioned above, make these notes in 
any multiple of $100. 

The best general plan for the disposition of 
money temporarily idle is doubtless to distri- 
bute it in a number of the different ways men- 
tioned above. One-third of your funds might 
be kept in a trust company or with a private 
banker at 2 or 3 per cent. ; another third in 
savings banks or building and loan associa- 
tions, and the last third in short-term notes or 
commercial paper. 

Such a distribution would contribute to safe 
ty and conditions could hardly arise which 
would prevent you from getting hold of enough 
money and acceptable collateral to make your 
purchases at the right time. 

It may be added that there is no logical rea- 
son why you should not "invest" on the short 



FOR PROFIT 143 

side of the market at times when you do not 
wish to buy. But this carries us a little out 
of the field we have marked out — namely, get- 
ting a profit in addition to regular interest. 
There is no good ground for the popular pre- 
judice against short selling, but the principles 
to be applied to it are somewhat different from 
those here discussed. 



CHAPTER XII 

THE THREE SOURCES OF PROFIT IN 
BUYING SECURITIES 

IN the chapters of which this is the conclud- 
ing number, I have endeavored to develop 
the subject in as simple and straight for- 
ward a way as possible, avoiding unnecessary- 
technicalities, and yet covering in a fairly sys- 
tematic manner the most important principles 
of the science. 

The reader has not failed to observe that my 
chief effort has been to bring this problem 
of investing for profit down from the clouds, 
in which it has been enveloped by statisticians, 
auditors, accountants and many financial writ- 
ers, and to present it in such a way that the 
practical business man or investor may apply 
his natural common sense to the matter of buy- 
ing and selling securities in much the same 
manner as he would apply it in the manage- 
ment of his own personal affairs. 

In summing up the principles of the science 
of investing for profit, we see that every oppor- 
tunity for making a profit in this way must 
come under one of three different heads: 

144 



FOR PROFIT 145 

(1) A transition in the money market from 
a high money rate to a low one. 

A continued high money rate naturally 
means low prices for interest-bearing securi- 
ties. When the conditions that have caused 
this abnormally high money rate pass away, 
and money becomes plentiful, it again seeks 
employment in interest-bearing securities, until 
the increased demand for these securities grad- 
ually lifts their prices to a higher level. The 
investor can participate in this upward move- 
ment by buying bonds or high-grade dividend- 
paying stocks as soon as the money situation 
takes a turn for the better, after a period of 
high rates.* 

Two methods have been suggested by which 
such a purchase may be made intelligently : 

(a) When a sound security is selling at a 
price which gives a much larger interest re- 
turn on the money invested in it than has been 
usual in the past history of that security, and 
larger than is usual for other similar securities, 
owing to a general high rate for money, the 
investor may buy it with confidence that it will 
sell at higher prices at some later date, when 
money conditions become easier. 

♦This subject is adequately treated in "Tidal Swings of 
the Market," by Scribner Browne. 



146 INVESTING 

Likewise, when a security reaches a price so 
high that the interest return on that price is 
abnormally low, the investor will sell, assum- 
ing that he will later have an opportunity to 
repurchase at a lower price. 

(b) By keeping a graph showing the aver- 
age high, low and closing prices of a well- 
selected list of stocks, together with the total 
volume of sales in the New York stock market, 
he will find the action of the market of some 
help in forming his opinion as to the best time 
to invest or to close out his investments. As 
for example, the period of quiet succeeding a 
disastrous panic, or dullness after a big spec- 
ulative boom. The conclusions drawn from 
this source, however, must be kept strictly 
supplementary to other considerations and not 
used as a main reliance. 

(2) The second class of opportunities for 
investing for profit arise from the change from 
dull business to active business. This follows 
the transition from high money to low money, 
but after a considerable interval. The length 
of this interval cannot be determined in ad- 
vance. With good crops and quiescent poli- 
tics the interval may be short, and bad crops 
or disturbing political conditions may lengthen 
it out to several years. 



FOR PROFIT 147 

All the methods mentioned above will aid 
the investor in buying his securities during a 
period of dull business, which will work out 
into renewed activity. Low price is, of course, 
an essential element; and both the money 
market and the stock market give important 
help by preceding or "discounting" improved 
general business. I have also called attention 
to three other principles which will aid the 
investor in making up his mind : 

(c) Per cent, of railroad operating expenses 
to gross earnings (Chapters IV and V). 

(d) Advance orders of industrial companies 
on the books (Chapter VII). 

(e) The extent to which surplus earnings 
are "plowed in" (Chapter VIII). 

(f) Maintenance of relatively high earnings 
during dull times (Chapter IX). 

(3) The third class of opportunities is 
found in the selection of the securities of a 
company which must grow, because of the fav- 
orable conditions by which it is surrounded. In 
this case all of the six methods mentioned 
above will be applied as tests, either to the 
general situation or to the particular security 
under consideration. 

In addition, two other methods have been 
discussed : 



148 INVESTING 

(g) Examination of the general conditions 
surrounding the company. 

(h) Study of the statistics covering the past 
history of the company and its securities. 

Both these subjects were taken up in Chap- 
ters VII, VIII, and IX. 

The desire of the investor will be to combine 
all of the above methods, so far as possible, 
in deciding what and when to buy or sell. He 
will naturally begin by keeping in mind me- 
thods (g) and (h) ; that is, noticing the general 
development and progress of leading companies 
and of different sections of the country, and 
keeping a brief statistical memorandum of re- 
sults shown by annual reports, as previously 
explained. 

In doing this, points (c), (d), (e) and (f) 
will put in their appearance and be duly con- 
sidered as a matter of course. 

The investor will soon have in mind a num- 
ber of securities that seem to him to be special- 
ly in line for growth, and will plan to buy 
them — when the right time comes. 

In deciding on the right time, he will con- 
sider methods (a) and (b). I have explained 
the necessary graphs, with the principles on 
which they are based. 

A number of mistakes may be briefly men- 



FOR PROFIT 149 

tioned, which should be avoided. One of the 
most common is becoming wedded to some 
particular theory or idea, so that it assumes 
in your mind a much greater importance than 
it does in the minds of others. It is necessary 
to consider all the facts impartially and to 
maintain a w r ell-balanced point of view. 

Another similar error consists in being in- 
fluenced by some personal prejudice, political 
or otherwise. 

It is a mistake to push a mathematical or 
statistical deduction to its extreme conclusion. 
It is, in fact, quite noticeable that the man of 
mathematical taste and training is not, as a 
rule, as good a judge of investments as the one 
of a more practical business temperament. 
Mathematics lead us to an absolute conclusion 
provided our premises are assured ; but in bus- 
iness or investment studies, the selection of 
the right premises is the most important con- 
sideration. 

In general, any extreme conclusion is to be 
distrusted, for even if it is correct it will not 
be credited by the majority of investors, and 
hence will not have its full effect on market 
prices. 

The worst mistake of all, probably, for the 
simon-pure investor for profit, is to be grad- 



150 INVESTING 

ually led into an effort to catch relatively 
small fluctuations in the market. If you elect 
to be an investor, stick to your chosen field, 
no matter what fine opportunities you may 
imagine yourself to be losing. If you want 
to speculate, learn how first, and keep your 
speculations strictly separate from your in- 
vestments. 



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The opportunities for profit in the bond 
market are not generally recognized. They ex- 
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One of the strong points of our Investment 
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